Reconciling the Reconciliation

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Reconciling the Reconciliation
Presented to IAAO Councils Sections Public
Utility Section Thursday May 11, 2006Charleston,
SC

• Presented by
• Mark Pomykacz, MAI
• Federal Appraisal Consulting LLC
• Phone [phone]
• E-mail mark_at_federalappraisal.com

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Mark Pomykacz, MAI

• Managing Partner, Federal Appraisal Consulting
  LLC
• Real estate and business appraisal and advisory
  services
• Specialize in complex issues and properties,
• IRS, SEC and other financial reporting
• Utilities, power plants and telecommunications
  assets
• Member of Appraisal Institute (MAI)
• Member of the National Board of Directors of the
  Appraisal Institute
• Teach Income Capitalization, USPAP and Various
  Seminars for the Appraisal Institute, IAAO,
  Baruch (CUNY) and New York University, and
  others
• State certified general real estate appraiser in
  multiple states
• Published several articles on appraisal and
  property taxes

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The Reconciling Issue

• Theory and Practice leaves many unprepared for
  complex reconciliation issues.
• The major appraisal treatises and journals
• Provide limited coverage.
• Often imply reconciliation is required.
• Often imply if a reconciliation is not completed,
  then it is due to appraiser incompetence, or
  worse.
• Usually a reconciliation is so obvious, that
  little thought is required, and even poorly
  written reconciliations are rarely challenged.

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Limited Coverage in the Major Treatises and
Journals
The Appraisal of Real Estate, 12th Edition 7
pages of 759 pages (0.9)
The Appraisal Journal and Other Journals 3
Articles
Valuing a Business, 4th Edition, Shannon Pratt 12
pages of 923 pages (1.3)
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Articles on Reconciliation
Proper Reconciliation in Narrative Reports Favors
Substance Over Form By Ralph H. Emerson, III,
MAI Notes and Issues, pg 94 Real Reconciliation
By R.H. Holstein, III, A.R.A 2003 JOURNAL OF THE
ASFMRA, pg 37 The Myth about Appraisal By Joe
Roberts Eric Roberts The Appraisal Journal,
April 1991, pg 212
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Definition - Reconciliation

• The last phase of any valuation assignment in
  which two or more value indications derived from
  market data are resolved into a final value
  opinion, which may be either a final range of
  value or a single point estimate.
• In the sales comparison approach, reconciliation
  may involve two levels of analysis 1) derivation
  of a value indication from the adjusted prices of
  two or more comparable sales expressed in the
  same unit of comparison and 2) derivation of a
  value indication from the adjusted prices of two
  or more comparables expressed in different units
  of comparison.

The Dictionary of Real Estate Appraisal, 4th
Edition
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Definition - Reconciliation Criteria
The criteria that enable an appraiser to form a
meaningful, defensible conclusion about the final
value opinion. Value indications are tested for
the appropriateness of the approaches and
adjustments applied, the accuracy of the data,
and the quantity of evidence analyzed.
The Dictionary of Real Estate Appraisal, 4th
Edition
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USPAP Reconciliation

• Standards Rule 1-6
• (This Standards Rule contains binding
  requirements from which departure is not
  permitted.)
•  
• In developing a real property appraisal, an
  appraiser must 
• reconcile the quality and quantity of data
  available and analyzed within the approaches
  used and
• reconcile the applicability or suitability of
  the approaches used to arrive at the value
  conclusion(s).  
• Comment See the Comments to Standards Rules
  2-2(a)(ix), 2-2(b)(ix), and 2-2(c)(ix) for
  corresponding reporting requirements.

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USPAP Reconciliation, 2

• Departure is not permitted (AO-15)
• A reconciliation must be adequate for the
  reports purpose and use. (10-2)
• Sales history must be reconciled with other
  indications of value. (AO-22)
• USPAP reconciliation requirements apply to
• Real
• Personal
• Consulting
• Mass Appraisal
• Business and Intangibles
• Assistants who can conduct most other aspects of
  the appraisal, may need help from a principle to
  reconcile. The report should disclose which
  parts were done by whom. (AO-5)

• Self Contained
• Summary
• Restricted Use

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The Appraisal of Real Estate

1. Diverse indications are common.
2. Reconciliation is not just for final indications
   of value
3. Also for reconciling adjusted sales comparables
4. And for reconciling various appraisal aspects.
5. The purpose and use of the appraisal will impact
   the scope of the reconciliation.
6. A reconciliation requires judgment. It is not an
   averaging process.
7. A reconciliation must be supported and explained.
8. Data may be best available, may not yield
   appropriate value.
9. Reconciliation involves setting a rounding policy

12th Edition
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Common Reconciliation Mistakes

1. Completing a reconciliation by rote.Conversely,
   failing to complete an approach/analysis because
   in otherwise similar circumstances, it is
   commonly not done.

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Common Reconciliation Mistakes, 2

1. Mixing indications that assume a different
   highest and best use.
2. Failing to account for needed, but incomplete,
   adjustments in deriving the indications.
3. Expecting all completed approaches to be
   reconcilable.
4. With out good reason, and/or in an inconsistent
   matter, simply changing various analysis
   assumptions in order to get the various
   indications to be the same.

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The Criteria

1. Appraisal Parameters Consistency with appraisal
   purpose, use and scope, and with highest and best
   use.
2. Theory What does appraisal theory say you
   should do?
3. Data Quality and Quantity Regardless of theory,
   what does the quality and quantity of the data
   allow you to do?

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The Theory Criteria

Question What does appraisal theory say you
should do? Answer Whatever your peers would
do. Question But what should my peers
do? Answer Whatever buyers and sellers
do. Question But what do buyers and sellers
do? Answer It depends on the property, and
the market. But whatever they do, we assume
it will follow rational laws of economics
concerning value, i.e. appraisal theory .
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The Theory Criteria, 2

• Examples
• SFH use sales, maybe cost, if new enough, but
  not income.Reconcile with all or nearly all
  weight to the sales.
• An apprentice appraiser, in their first month on
  the job, learns that both his peers and the
  market do this.
• Apartment Building - primarily use income, maybe
  sales (if data is good), and maybe cost, if new
  enough and if market is near equilibrium.
• An apprentice appraiser, in their first year on
  the job, learns that both his peers and the
  market do this.
• Thereafter its rote.
• But what are the economic principles that explain
  the actions.

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The Economic Theory - SFH

• Buyers do not buy for the income. They buy for
  their own use.
• They sometimes build for their own use.
• Buyers comparison shop.
• They even compare the cost to build versus the
  price of existing homes.
• Overwhelmingly, they do not consider the income
  potential.
• Principles of substitution, not principles of
  economic anticipation, apply.
• So use sales, sometimes use cost, do not need
  income.
• If clients purpose and use is limited, then use
  sales only.
• If clients purpose and use is expansive, then
  use sales and cost, but still not income, unless
  subject and/or market has an income potential.

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The Economic Theory - Apartments

• Buyers buy apartment homes for the income. They
  do not buy for their own use.
• They sometimes build for income potential.
• Buyers comparison shop.
• They even compare the cost to build versus the
  price of existing.
• They emphasize the income potential.
• Principles of economic anticipation apply, but
  principles of substitution are used to measure
  the value of the anticipated income.
• So use sales, sometimes use cost, but emphasize
  income.
• Sales must have similar income potentials, and
  highest best uses.
• Cost must reflect all economic obsolescence,
  along with functional and physical obsolescences.

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Market CyclesU.S. Office Market Cycle Positions

Source Pricewaterhouse Coopers
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Market CyclesU.S. Multifamily Market Cycle
Positions

Source Pricewaterhouse Coopers
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Cost vs. Value
Probably Excess Profit
Probably Economic Obsolescence
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Cost vs. Value
Probably Excess Profit
Probably Economic Obsolescence
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The Appraiser as Mimic

• Appraisers should do what the market does!

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Appraisers in Action
Survey of Assessors, Owners, Appraisers and
Representatives

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Question 1a

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Question 1b
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Question 1c
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Question 2a
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Question 2b
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Question 2c
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Question 3a
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Question 3b
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Question 3c
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Question 4a
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Question 4b
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Question 4c
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Question 5
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Question 6a
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Question 6b
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Question 7a
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Question 7b
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Question 8
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Question 10
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Cost, Income, Sales
RegulatedMarket DeregulatedMarket
Minimal Most Minimal Some
Minimal Most
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Cash is King
All businesses produce the same thing CASH!
AKA Income or Cash Flow Thus, The Income
Approach is King
Not Capitalist. Rather Cash Flowist Cash
Flowite Cash Flowian
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Practical Considerations

1. Size of absolute adjustments
2. Typical data quality and quantity

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Conclusions

1. Avoid the usual mistakes.
2. Not all completed approaches can be reconciled.
3. Use appraisal theory to the extent possible to
   reconcile
4. Mimic the market
5. Use economic theory
6. Use practical considerations
7. Size of absolute adjustments
8. Typical data quality and quantity

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Questions?

• Questions?