Have you ever read thru an appraisal report? You may have noticed that there are three approaches to value. The Sales Comparison Approach, the Cost Approach, and the Income Approach.
The Sales Comparison approach, as the name implies, compares the property being appraised to other properties that a potential buyer might consider as a substitute for buying the property being appraised.
The Cost Approach is where a value is developed by determining the value of the land, and the replacement or reproduction cost of the improvements, or proposed improvements, on the property.
I complete this approach on nearly every appraisal, with the exception of condominiums, because it is a necessary approach when measuring the accrued depreciation of a property, which provides helpful information in the Sales Comparison Approach. Even if I do not include my development of the Cost Approach in my report, I have it in my work file.
The third approach to value is the Income Approach. As the name implies, in this approach income, or potential income is converted into value using either a capitalization rate or gross rent multiplier, which are factors that convert income into value.
This approach is completed typically for income properties, such as multi-family homes or homes being used as investment properties, or in areas where many of the homes that are similar to the one being appraised are being used as investment properties.
When completing an appraisal, there may be four values. You might be thinking, since there are only three approaches to value, there would only be three values, if all three approaches were developed, right? I’m glad you asked! Let’s talk about that fourth opinion of value.
WHAT DO APPRAISERS DO WITH EACH VALUE?
What does the appraiser do with the three different values that may be developed? The appraiser must now reconcile these three values into one final opinion of value. How?
One definition of the word reconcile in Dictionary.com is “to bring into agreement or harmony; make compatible or consistent.” In the Reconciliation section of the appraisal report, the appraiser should bring into “harmony” the different values. In other words, some commentary needs to be written explaining why each approach was developed, or not developed, and some commentary on the availability and reliability of the data used.
The appraiser will determine which of the values is most appropriate and reflective of demonstrating the market value of the property being appraised. Once this happens, the appraiser will explain which approach to value was given the most weight, or consideration, and why. I will often use a weighted average, giving the most weight to the most relevant and reliable approach.
Standards Rule 1-5 in the Uniform Standards of Professional Appraisal Practice (USPAP) states that when appraising a real property, an appraiser must:
(a) reconcile the quality and quantity of data available and analyzed within the approaches used; and
(b) reconcile the applicability and relevance of the approaches, methods and techniques used to arrive at the value conclusion(s).
If you look at the small amount of space provided in the Fannie Mae/Freddie Mac form I shared above, there’s really not enough room to adequately comment on these things. At least in my opinion. Therefore, in my reports, my reconciliation is on a separate addendum.
APPRAISING FOR LENDERS
When performing work for banks, on a fairly regular basis, a reviewer will bounce my report back if my opinion of value in the Sales Comparison Approach is different than my reconciled final opinion of value. Usually, they think it is a typo. Respectfully, if they had read my report and not just looked at the values, they would know exactly why they are different and how I developed them.
This also tells me that many appraisers may not be reconciling the different approaches to value. They simply give all weight to the Sales Comparison Approach every time. In fairness, many times the reconciled value is the same as the value in the Sales Comparison Approach. But not always.
I have had lenders, and even some well-intentioned appraisers tell me that for Fannie Mae loans, all weight must be given to the Sales Comparison Approach. Is that really true? If the opinion of value in the Sales Comparison Approach was always supposed to be the same as the final reconciled opinion of value, then what sense would it make to have a separate space for a fourth value in Fannie Mae and Freddie Mac’s own form?
Here’s what Fannie Mae says in their 2021 Seller’s Guide regarding the final reconciliation:
“In the Reconciliation section of the appraisal report form, the appraiser considers the reliability and applicability of each of the approaches to value that was utilized in the appraisal report. After consideration of each of the approaches to value, the
appraiser will provide his or her final value opinion. In the Reconciliation section, appraisers must:
• reconcile the reasonableness and reliability of each applicable approach to value,
• reconcile the reasonableness and validity of the indicated values,
• reconcile the reasonableness of available data, and
• select and report the approach or approaches that were given the most weight.
The reconciliation is based on the appraiser’s judgment of the results developed as part of the valuation process and must never be an averaging technique with the exception of the use of a weighted average technique that includes a proper explanation. The final reconciled indicated value must be within the range of the values indicated by the Approaches used in the appraisal report form.”
I get questions about this on a regular basis from reviewers. This tells me that most appraisers give all weight to the Sales Comparison Approach most if not all of the time. But is that always appropriate?
When my final reconciled value differs from my opinion of value in the Sales Comparison Approach, when a lender questions this, once I explain it to them, they have always accepted my report. Lenders are not value experts. Appraisers are. When we are questioned on our work, we should be ready to explain and educate our clients on specific aspects of an appraisal.
Let me give you a real-world example. I recently completed an appraisal of a property where the home was not built yet. My opinion of value was based on the proposed improvements. (Plans and specifications of the home to be built) I developed values using the Sales Comparison and the Cost Approach. I had very few even remotely comparable sales to choose from for comparison. None were great. I used the best market data that I could find.
I did have good market data for developing the value of the land. I also had good data for the construction cost (replacement cost). And the property being appraised had not been built yet. Therefore, in my reconciliation, I gave more weight to the value developed in the Cost Approach than I did the value I developed in the Sales Comparison Approach.
My final reconciled opinion of the market value of the property was higher than the value developed in the Sales Comparison Approach because I gave the most weight to the value in the Cost Approach.
As you can imagine, the lender bounced my report back stating that this is not acceptable. It clearly did not meet UAD criteria, which red flags an appraisal when the reconciled opinion of value is higher than the adjusted range in the Sales Comparison Approach.
I explained my reasoning again, even though if they had read my report, they would have understood my reasoning and how I developed my reconciled opinion of value.
After providing them with some additional market data and explanation, they accepted the report with my opinion of value never changing despite my reconciled opinion of value being higher than my opinion of value in the Sales Comparison Approach.
When a proper reconciliation is completed in a report, it can add meaning and support to an appraiser’s opinion of value. It’s an important step in the development of an opinion of value. If a lender pushes back, my advice to appraisers is to not cave to the pressure of the lender. If the appraiser did not make a mistake, and the lender just doesn’t understand the appraisal process, that’s a golden time to help educate the lender.
Of course, if the lender points out something that we did do incorrectly, then it would also be wise to correct our mistake. Either way, it is important that we understand what we did and why we did it, and be able to explain it!
That’s all I have for this week! Thank you so much for being here! You may have noticed that I have had a lot of guest bloggers lately. I hope you’ve been enjoying their articles!
At the end of May, I severely stress-fractured my leg running. I was on crutches for most of June and July, which made appraising a little interesting. Three weeks ago, I had surgery on my leg. They inserted a titanium rod right down the center of my tibia. Long story short, I can walk again without crutches! Awesome! Here is an x-ray of my leg now. (Not for the faint of heart) It’s pretty amazing what doctors can do these days! And I am grateful!
Anyhow, I’m a little more bionic than I used to be. As Ace Ventura once said, “It’s in the bone…It’s in the bone!”
With that in mind, this week I leave you with a little Ace Ventura for your entertainment. The quote I am referring to is at the end of this clip. Enjoy!
Have a great weekend!
I’ve just released a new episode into the world. I hope you enjoy it!
If you enjoy listening to podcasts, check out mine. I hope you enjoy it! You can find me on Apple Podcast, iHeart Radio, Spotify, Google Play Music, Sound Cloud, Radio.com, RadioPublic, Deezer, Breaker, Stitcher, and other feeds.
You can also listen right here at Cleveland Appraisal Blog!
I am a member of the National Association of Appraisers. If you’re an appraiser, and you’re looking to join an appraisal organization, please check them out. The NAA is made up of fantastic appraisers from across the country who are working hard to keep their fellow appraisers up to date on what’s happening.
If you’re an appraiser and you’re looking to gain some new analytical skills, check out George Dell’s Stats, Graphs, and Data Science 1. Click here to register.
Here are some links to other articles I’ve enjoyed recently! I hope you will also…
Is the Sun Setting on High Prices? – DW Slater Appraisal Blog
Will My House Appraise for Its Selling Price? 10 Tips to Avoid a Low Valuation – Lori Lovely with HomeLight
How to Prospect Your Way to 15 Listings Every Month – The Walkthrough Podcast
USPAP’s Useless Cost Approach – The Appraiser’s Advocate Podcast
Bias In The Transaction Zone? – George Dell’s Analog Blog
6 Things to Consider When Comparing Your Home To Recent Neighborhood Sales – Birmingham Appraisal Blog
Changing housing temperature – Sacramento Appraisal Blog
Cost Approach – When to Use in Appraisals – APPRAISAL TODAY
For my readers in the CLE area… here are some articles related to news in our local area. I hope you enjoy these also…
Vintage Brand History Series: Coppercraft Guild – The Mustard Dandelion Blog
Interlake Steamship Co. launches first cargo ship to hit the Great Lakes in more than 40 years – Tom Matowitz of Fresh Water Cleveland