reconciling the reconciliation presented by: mark pomykacz, mai federal appraisal & consulting...
TRANSCRIPT
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Reconciling the ReconciliationReconciling the Reconciliation
Presented by:
Mark Pomykacz, MAIFederal Appraisal & Consulting LLCPhone: (908) 534-3590
E-mail: [email protected]
Presented to:
IAAO Councils & SectionsPublic Utility Section
Thursday May 11, 2006Charleston, SC
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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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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.
The Reconciling Issue
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Limited Coverage in the Major Treatises and Journals
The Appraisal of Real Estate, 12th Edition7 pages of 759 pages (0.9%)
Valuing a Business, 4th Edition, Shannon Pratt12 pages of 923 pages (1.3%)
The Appraisal Journal and Other Journals3 Articles
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Articles on Reconciliation
Proper Reconciliation in Narrative ReportsFavors Substance Over FormBy Ralph H. Emerson, III, MAINotes and Issues, pg 94
Real Reconciliation By R.H. Holstein, III, A.R.A2003 JOURNAL OF THE ASFMRA, pg 37
The Myth about AppraisalBy Joe Roberts & Eric RobertsThe Appraisal Journal, April 1991, pg 212
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Definition* - Reconciliation
1. 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.
2. 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:
(a) reconcile the quality and quantity of data available and analyzed
within the approaches used; and
(b) 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
1. Departure is not permitted (AO-15)2. A reconciliation must be adequate for the report’s purpose and use.
(10-2)3. Sales history must be reconciled with other indications of value. (AO-
22)4. USPAP reconciliation requirements apply to:
• Real• Personal• Consulting• Mass Appraisal• Business and Intangibles
5. 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 value1. Also for reconciling adjusted sales comparables
2. And for reconciling various appraisal aspects.
3. The purpose and use of the appraisal will impact the scope of the reconciliation.
4. A reconciliation requires judgment. It is not an averaging process.
5. A reconciliation must be supported and explained.
6. Data may be best available, may not yield appropriate value.
7. 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.
Scope of Appraisal
Reconciliation
Purpose and Use
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Common Reconciliation Mistakes, 2
2. Mixing indications that assume a different highest and best use.
3. Failing to account for needed, but incomplete, adjustments in deriving the indications.
4. Expecting all completed approaches to be reconcilable.
5. 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
1. 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.
2. 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 client’s purpose and use is limited, then use sales only.• If client’s 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
Residential Apartment
-0.4
0
0.4
0.8
1.2
1.6
2
2.4
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
BLS Cost Index (20% EI) BLS Cost Index
NCREIF Value BLS Cost Index (20% loss)
Probably Economic Obsolescence
Probably Excess Profit
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Cost vs. Value
Office Space
-4
-3
-2
-1
0
1
2
3
4
5
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
BLS Cost Index NCREIF Value BLS Cost Index (20% EI) BLS Cost Index (20% loss)
Probably Economic Obsolescence
Probably Excess Profit
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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
0
2
4
6
8
10
12
14
16
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Acqusition/Disposition Cost Approach
Other
Both
Owner
Assessor
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Question 1b
0
2
4
6
8
10
12
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Acquisition/Disposition Income Approach
Other
Both
Owner
Assessor
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Question 1c
02468
1012141618
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Acquistion/Disposition Sales Approach
Other
Both
Owner
Assessor
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Question 2a
0
5
10
15
20
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Acquisition/Disposition Cost Approach
Other
Both
Owner
Assessor
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Question 2b
0
5
10
15
20
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Acquisition/Disposition Income Approach
Other
Both
Owner
Assessor
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Question 2c
0
2
4
6
8
10
12
14
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Acquisition/Disposition Sales Approach
Other
Both
Owner
Assessor
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Question 3a
0
5
10
15
20
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Property Tax Cost Approach
Other
Both
Owner
Assessor
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Question 3b
0
2
4
6
8
10
12
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Property Tax Income Approach
Other
Both
Owner
Assessor
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Question 3c
0
5
10
15
20
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Regulated Property Tax Sales Approach
Other
Both
Owner
Assessor
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Question 4a
0
2
4
6
8
10
12
14
16
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Property Tax Cost Approach
Other
Both
Owner
Assessor
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Question 4b
0
5
10
15
20
25
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Property Tax Income Approach
Other
Both
Owner
Assessor
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Question 4c
0
2
4
6
8
10
12
14
16
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Deregulated Property Tax Sales Approach
Other
Both
Owner
Assessor
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Question 5
0 5 10 15 20 25
1
Different Approaches for Different Power Plants
Always
Frequently
Occasionally
Never
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Question 6a
02468
1012141618
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Market Value via Income Approach Direct Cap
Other
Both
Owner
Assessor
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Question 6b
0
5
10
15
20
25
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Market Value via Income ApproachDiscounted Cashflow
Other
Both
Owner
Assessor
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Question 7a
0
2
4
6
8
10
12
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Market Value via Cost Approach Replacement Cost
Other
Both
Owner
Assessor
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Question 7b
0
2
4
6
8
10
12
14
NoWeight
MinimalWeight
EqualWeight
MostWeght
AllWeight
Market Value via Cost Approach Reproduction Cost
Other
Both
Owner
Assessor
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Question 8
0 1 2 3 4 5 6 7 8 9
Acquisition
SEC Reporting
Property Tax Assessment (ow ner)
Property Tax Assessment (taxer)
Federal Tax Reporting
State/Local Tax Reporting
Insurance
Financial modeling
Other
Purpose of Appraisal
Other
Both
Owner
Assessor
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Question 10
0 2 4 6 8 10 12 14
All of U.S.
CAISO
MISO
NYISO
ISD-NE
PJM
SPP
Other, Please Specify
Regions Practiced In
Assessor
Owner
Both
Other
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Cost, Income, Sales
Sales Cost Income
Direct Capitization Yield Capitalizaton
Appraisal
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
1. Mimic the market
2. Use economic theory
4. Use practical considerations
1. Size of absolute adjustments
2. Typical data quality and quantity
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Questions?
Questions?Questions?