How Adjustments are made for the appraisal of Single Family Residences
Dedication: “This blog post is dedicated to my older brother George and my younger brother Michael, both of whom have expressed to me on more than one occasion that they believe that appraisers make up the numbers on the adjustment grid out of thin air with no real basis in fact.”
Linear Regression:
The most common and accepted method of valuing a single family residence is the market approach and this is the approach that appears on page 2 of an appraisal report. In it's basic form this process consist of comparing analyzing three comparable properties The process performed on the adjustment grid is called a linear regression. Linear Regressions, if you remember your Algebra 102, are very useful for solving a problem with multiple unknown variables. The mathematical function for this process is expressed as:
Y = a + b1*X1 + b2*X2 +... + bp*Xp.
The adjustment grid utilized in the appraisal report is the mathematical equivalent of this formula, however it is more readable than a page full of calculations and functions.
The adjustment grid:
The adjustment grid allows you to solve for multiple unknown variables. To put it in a practical sense, you can get a pretty good idea that: a house with a two car garage will command $25,000 more than a house with a one car garage; or that homes with remodeled kitchens will sell for $15,000 more than a homes not similarly remodeled, in a particular neighborhood or economic area.
And if you know the values for the individual features or deficiencies for the property that you are appraising, you can add, in the case of features; or subtract, in the case of deficiencies, that amount, to the sales prices of three comparable properties and the resultant forms the basis for a value conclusion. This is the foundation of the market approach to value.
Comparable sale properties should be close in proximity to the subject, similar in living area and room count and equivalent in quality and condition but more importantly, they must constitute matched pairs, without which the linear regression will not work.
In the abbreviated adjustment grid below, the matched pairs are highlighted in yellow. In this case the matched pairs for the garage adjustment are comparables number 1 and 3 and the matched pairs for the kitchen remodeling are comparables number 1 and 2. If you do not have matched pairs for any particular item, you cannot make an accurate adjustment.
I direct your attention to the "adjustment spread', which is indicated by caption and highlighted in green. The spread is $40,000 and no adjustments have been made. The adjustment spread is the difference between the highest and the lowest after adjusted values for the comparables.
And if you know the values for the individual features or deficiencies for the property that you are appraising, you can add, in the case of features; or subtract, in the case of deficiencies, that amount, to the sales prices of three comparable properties and the resultant forms the basis for a value conclusion. This is the foundation of the market approach to value.
Comparable sale properties should be close in proximity to the subject, similar in living area and room count and equivalent in quality and condition but more importantly, they must constitute matched pairs, without which the linear regression will not work.
In the abbreviated adjustment grid below, the matched pairs are highlighted in yellow. In this case the matched pairs for the garage adjustment are comparables number 1 and 3 and the matched pairs for the kitchen remodeling are comparables number 1 and 2. If you do not have matched pairs for any particular item, you cannot make an accurate adjustment.
I direct your attention to the "adjustment spread', which is indicated by caption and highlighted in green. The spread is $40,000 and no adjustments have been made. The adjustment spread is the difference between the highest and the lowest after adjusted values for the comparables.
In the areas that the subject is superior to the comparable, you must make an adjustment by adding the value difference to the sales price of the comparable on the corresponding line of the adjustment grid, and in areas that the subject is inferior, you must subtract the value difference from the sales price of the comparable on the grid.
Watching the spread is and important indicator and can tell you, most of the time, if you are headed in the right direction with your adjustments.
First we assume values for the garage and kitchen differences. The starting value that you choose is really not all that important but it makes the job easier if you start reasonably close. We start on this one with $20,000 for both the garage and the remodeled kitchen.
Watching the spread is and important indicator and can tell you, most of the time, if you are headed in the right direction with your adjustments.
This is how it works:
First we assume values for the garage and kitchen differences. The starting value that you choose is really not all that important but it makes the job easier if you start reasonably close. We start on this one with $20,000 for both the garage and the remodeled kitchen.
First iteration:
The spread has dropped to $5,000 on our first "guess". But what happens if we try different numbers and different combinations of numbers? The process of trying different numbers and comparing the outcomes is called iteration. The example below shows the results of nine iterations.
After nine combinations of numbers, it seems to me that the value for the extra garage space is $25,000 and the value for the kitchen remodeling is $15,000.
What is essential to the process is consistency. The process of adjusting is a mechanical means of solving the previously referenced equation, but it is still an equation and equations must always be balanced. If you make a $25,000 positive adjustment in favor of the subject for having a two car garage against a property with a one car garage, you must subtract the same amount from the sales price of a comparable that has a three car garage if it is used in the same appraisal report.
Now, lets see what you learned, if anything.
The following exercise is to see if you can figure out the value of a pool.
The three comparables below are exactly the same but comparable # 3 has a pool. What is the value of the pool? Remember to go for the lowest spread.
What is essential to the process is consistency. The process of adjusting is a mechanical means of solving the previously referenced equation, but it is still an equation and equations must always be balanced. If you make a $25,000 positive adjustment in favor of the subject for having a two car garage against a property with a one car garage, you must subtract the same amount from the sales price of a comparable that has a three car garage if it is used in the same appraisal report.
Now, lets see what you learned, if anything.
The following exercise is to see if you can figure out the value of a pool.
The three comparables below are exactly the same but comparable # 3 has a pool. What is the value of the pool? Remember to go for the lowest spread.
If you had trouble figuring out the pool value, maybe you should just call me to do that report for you.
If you estimated $20,000 to $25,000, you would have successfully performed a linear regression with one variable. I like $25,000 for several reasons but primarily because it brackets the adjusted values of the matched pairs (comp #1 and comp # 2) to the one unadjusted comparable (comp # 3). Just another level of attention to detail.
If you estimated $20,000 to $25,000, you would have successfully performed a linear regression with one variable. I like $25,000 for several reasons but primarily because it brackets the adjusted values of the matched pairs (comp #1 and comp # 2) to the one unadjusted comparable (comp # 3). Just another level of attention to detail.
Now you have only to plug in that adjustment into comparable 1 and 2 and you get the grid below.
Now lets apply everything that has been presented and see if you can determine the value of the subject property on the adjustment grid below. This is an easy one.
The ground rules are that the appraised value cannot be higher than the pre-adjusted sales price of the highest comparable and it must be within the range of the spread of the after-adjusted value of all of the comparables and the net overall adjustment for any single comparable cannot be more than 25% and the overall gross adjustment for any single comparable cannot be more than 33%.
Got all that? Okay, go to it!
Whats it worth?
The ground rules are that the appraised value cannot be higher than the pre-adjusted sales price of the highest comparable and it must be within the range of the spread of the after-adjusted value of all of the comparables and the net overall adjustment for any single comparable cannot be more than 25% and the overall gross adjustment for any single comparable cannot be more than 33%.
Got all that? Okay, go to it!
Whats it worth?
And the finished product looks like the example below:
The appraised value is $525,000. The range between the highest and lowest adjusted value of the comparables is $520,000 to $530,000 but we are limited to $525,000 because that is the highest unadjusted value of the comparables.
Certain items are numerical quantities like; lot size, room count, and living area, and as such can be computed using "x" number of dollars per unit of measure. If the comparable has more rooms than the subject, as is the case with comparable # 1 in the example below, you multiply the difference in total rooms times the factor, which is the number to the far right. The subject's room count is: 6 3 2, and comparable number one is: 7 4 3. The total room count is 2 since comparable # 1 has one more room and one more bathroom than the subject, the subject is inferior by two rooms. Two rooms times the factor of $25,000 comes to $50,000 and since the subject is inferior in this respect, you enter a -$50,000 on the adjustment grid. This amount will be totaled with the other adjustment to provide a total adjustment for this comparable that will ultimately be added or subtracted from the sales price of that comparable..
Living area works the same way by multiplying the area difference is square feet times the factor for living area. In this case the factor is $125 / Square foot.
The matched pairs in the example below are both superior and inferior to the subject, resulting in a positive and a negative adjustment on the same line. This is called bracketing and bracketing your data makes for really strong arguments in defending your report against challenges. Just something to consider when preparing an appraisal report at the request of an attorney.
Items that are numerical quantities:
Certain items are numerical quantities like; lot size, room count, and living area, and as such can be computed using "x" number of dollars per unit of measure. If the comparable has more rooms than the subject, as is the case with comparable # 1 in the example below, you multiply the difference in total rooms times the factor, which is the number to the far right. The subject's room count is: 6 3 2, and comparable number one is: 7 4 3. The total room count is 2 since comparable # 1 has one more room and one more bathroom than the subject, the subject is inferior by two rooms. Two rooms times the factor of $25,000 comes to $50,000 and since the subject is inferior in this respect, you enter a -$50,000 on the adjustment grid. This amount will be totaled with the other adjustment to provide a total adjustment for this comparable that will ultimately be added or subtracted from the sales price of that comparable..
Living area works the same way by multiplying the area difference is square feet times the factor for living area. In this case the factor is $125 / Square foot.
The matched pairs in the example below are both superior and inferior to the subject, resulting in a positive and a negative adjustment on the same line. This is called bracketing and bracketing your data makes for really strong arguments in defending your report against challenges. Just something to consider when preparing an appraisal report at the request of an attorney.
Lot size adjustments work pretty much the same way but you have to consider the "utility" of the lot difference, which is a whole new vein, and which I have no intention of opening here.
Neighborhood adjustments can also be made but you should have more than the minimum three comparables to back up that assumption and of course, they must be matched pairs.
In the numerous conversations that I have had with my skeptical male siblings, an issue that always seems to arise is; "If the valuation of a property is not subjective and if appraisers are actually calculating a value, why is it then, that when a house sells, the appraiser will come up with exactly the value that the house sold for?"
The implication being that appraisers "back into" the value by 'fudging" the numbers until the appraised value matches the sales price. This assertion is generally followed up by "I could do that, as a matter of fact, anyone could."
I do take exception to the assertion that an uninitiated person could do just as well as an experienced appraiser but in all honesty I have always avoided answering this question directly because there is a kernel of truth to it. The explanation to counter this argument, however, would take much too long to be delivered over cocktails and friendly conversation, as it would entail all of the preceding explanations as to "how adjustments are done" plus an additional explanation of the difference between appraisals of sale properties and appraisals to discover the value of a house that is not, and has not been on the market.
I have previously stated that to perform a basic appraisal, we take the information from a minimum of three similar properties in the area of the subject, that have sold in the recent past and compare them to the subject in an regression analysis to determine the value of our subject property.
When a house has sold, we have one additional and very helpful piece of information and that is the sales price of that property. As it is market information that we are analyzing, it makes sense to consider this most recent and relevant sales information. To quote an old appraiser's axiom, "your best comparable is the sale that you are appraising".
But having the sales price and having comparables to support that sales price are two very different things. Sale properties must be selected that meet the criteria for valid comparables, which means they must be similar in location and size, they must contain "matched pairs", they must be run through the regression analysis and the spread has to be reasonably narrow and the equation must be balanced.
If a house sells for $755,000 and the appraiser calculates a value of $750,000 and the sale price fits within all of the parameters we have previously discussed, in addition to being of a value that is lower than the highest unadjusted comparable and within the range of the highest and lowest adjusted comparable, and if you do not want an angry lender calling you and asking you why you think that the subject is worth $5,000 dollars less than a willing buyer paid for it, it makes sense to make the final value correspond with the sales price. No appraiser that I know is bold enough to say that he/she can nail down a value to within a 5% margin of error. In this case, we defer to the market.
One case of having a sales price In rare cases, the sales price is deliberagely inflated to get a high appraisal which would facilate transferring a property with no money down or cash back to the buyer. We have a sales price in this case but no matter how much we adjust the numbers don't make sense. A fore instance would be if you had to state in your report that even though all of the three bedroom comparables are selling for 200,000, this one has four so we give it a 100000 adjustment to make a sales price of 300,000. No one would believe that.
In the real world, it would be rare indeed to actually null out a spread so that all three comparables adjust to the same value. We do, however, endeavor to get as close as passable.
Also, I am obligated to point out that none of the aforementioned rules are absolute and must be tempered with judgment. One must take into consideration the relationship between the numbers on the grid and hard reality. In any case, any such deviation from these guidelines must be accompanied with a succinct statement as to why that deviation was made and that explanation must be corroborated by market data contained in the report.
And now for some more iteration.
Are you ready to try a little iteration on your own? in the following example, the subject property sold for $545,000. I made it a little easier for you by picking out the comparables and marking the matched pairs in yellow. All you have to do is put in the adjustments.
Remember that the matched pairs are the only items where you can, and must make an adjustment. If the comparable is superior to the subject, make a negative adjustment and place it on the line next to the appropriate comparable, and if the comparable is inferior, make a positive adjustment on the line next to that comparable. Make sure that you maintain consistency and watch the spread.
you should be able to null out that spread in and iteration or two or three or x+n.
And to my dear brothers, I got two things to say to you guys. The first is to thank you both for providing the initial motivation for me to complete this piece and explain what the heck I have been doing all of these years and the second is:
ITERATE THIS!!!!!
Neighborhood adjustments can also be made but you should have more than the minimum three comparables to back up that assumption and of course, they must be matched pairs.
Just one more question!
In the numerous conversations that I have had with my skeptical male siblings, an issue that always seems to arise is; "If the valuation of a property is not subjective and if appraisers are actually calculating a value, why is it then, that when a house sells, the appraiser will come up with exactly the value that the house sold for?"
The implication being that appraisers "back into" the value by 'fudging" the numbers until the appraised value matches the sales price. This assertion is generally followed up by "I could do that, as a matter of fact, anyone could."
I do take exception to the assertion that an uninitiated person could do just as well as an experienced appraiser but in all honesty I have always avoided answering this question directly because there is a kernel of truth to it. The explanation to counter this argument, however, would take much too long to be delivered over cocktails and friendly conversation, as it would entail all of the preceding explanations as to "how adjustments are done" plus an additional explanation of the difference between appraisals of sale properties and appraisals to discover the value of a house that is not, and has not been on the market.
I have previously stated that to perform a basic appraisal, we take the information from a minimum of three similar properties in the area of the subject, that have sold in the recent past and compare them to the subject in an regression analysis to determine the value of our subject property.
When a house has sold, we have one additional and very helpful piece of information and that is the sales price of that property. As it is market information that we are analyzing, it makes sense to consider this most recent and relevant sales information. To quote an old appraiser's axiom, "your best comparable is the sale that you are appraising".
But having the sales price and having comparables to support that sales price are two very different things. Sale properties must be selected that meet the criteria for valid comparables, which means they must be similar in location and size, they must contain "matched pairs", they must be run through the regression analysis and the spread has to be reasonably narrow and the equation must be balanced.
If a house sells for $755,000 and the appraiser calculates a value of $750,000 and the sale price fits within all of the parameters we have previously discussed, in addition to being of a value that is lower than the highest unadjusted comparable and within the range of the highest and lowest adjusted comparable, and if you do not want an angry lender calling you and asking you why you think that the subject is worth $5,000 dollars less than a willing buyer paid for it, it makes sense to make the final value correspond with the sales price. No appraiser that I know is bold enough to say that he/she can nail down a value to within a 5% margin of error. In this case, we defer to the market.
One case of having a sales price In rare cases, the sales price is deliberagely inflated to get a high appraisal which would facilate transferring a property with no money down or cash back to the buyer. We have a sales price in this case but no matter how much we adjust the numbers don't make sense. A fore instance would be if you had to state in your report that even though all of the three bedroom comparables are selling for 200,000, this one has four so we give it a 100000 adjustment to make a sales price of 300,000. No one would believe that.
Reality Check
In the real world, it would be rare indeed to actually null out a spread so that all three comparables adjust to the same value. We do, however, endeavor to get as close as passable.
Also, I am obligated to point out that none of the aforementioned rules are absolute and must be tempered with judgment. One must take into consideration the relationship between the numbers on the grid and hard reality. In any case, any such deviation from these guidelines must be accompanied with a succinct statement as to why that deviation was made and that explanation must be corroborated by market data contained in the report.
And now for some more iteration.
Iteration means:
You just gotta keep doing it over - and - over until you get it right.
You just gotta keep doing it over - and - over until you get it right.
Are you ready to try a little iteration on your own? in the following example, the subject property sold for $545,000. I made it a little easier for you by picking out the comparables and marking the matched pairs in yellow. All you have to do is put in the adjustments.
Remember that the matched pairs are the only items where you can, and must make an adjustment. If the comparable is superior to the subject, make a negative adjustment and place it on the line next to the appropriate comparable, and if the comparable is inferior, make a positive adjustment on the line next to that comparable. Make sure that you maintain consistency and watch the spread.
you should be able to null out that spread in and iteration or two or three or x+n.
And to my dear brothers, I got two things to say to you guys. The first is to thank you both for providing the initial motivation for me to complete this piece and explain what the heck I have been doing all of these years and the second is:
ITERATE THIS!!!!!
And for the less gifted, the finished product:
And that folks, is pretty much the way Appraisers make adjustments.
Paul J. James AG 014884
California State Certified General Real Estate Appraiser
Paul J. James AG 014884
California State Certified General Real Estate Appraiser
PaulJames@Pacbell.net
Other sites: WWW.PaulJamesWorld.com and Http://Sausalitoischanging.blogspot.com
Sorry for the small illustrations in this one. If you double click on them, they get big.
posted by Paul James at
9:17 PM
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