The sequence of adjustments, and the magnitude of how they can drastically impact the final value in the Direct Sales Comparison Approach, are the focus of this piece.
The first adjustment to be made in the Direct Sales Comparison Approach is for seller paid concessions. Concessions (cash back, seller carried paper, personal property, boats, planes, country club memberships, interest only loans, 3-2-1 buy downs or other factors), thrown into deals to help make the price work, need to be adjusted for by the professional appraiser.
In the market cycle we are in, this one adjustment (concessions) can reach more than 20% of the purchase price. It can be larger than all other adjustments. Imagine, not knowing about the Terms and Concessions in the comparable sales relied upon, and being 20% high on a regular basis!
Step two of the Direct Sales Comparison Approach requires appraisers to verify the motivations, terms and conditions of a sale; prior to using it in a report for the reliance of others. Or at least that is what I have read on court documents when appraisers are being sued.
It does not really matter how big this adjustment is, does it? If a seller gave the buyer 25% cash back, that is just a fact. The definition of Market Value is in terms of Cash to the Seller. That's not too hard to calculate, once you have verified the information.
The next adjustment is for Time or Market Conditions. Pretend you are in a Zip Code or City that statistically went down 12% in the last year. And, pretend that in the last month, the actual decline, which you can prove, was 3%. The prior month is was 2.5% and 2% the month before. Then, using a 3-month old sale would result in a -7.5% adjustment.
The Time adjustment is not a static number. Going up or going down, it starts out slow, then picks up steam and increases, then it reaches a point where the rate begins to slow, then it slows down, and finally it stops. Stops for ever so brief a period, compared to the run-up or the run-down.
A market is normally stable for only a few months. It might go up for several years or down for several years. It is not stable for years at a time. That is simply counter intuitive if you understand supply, demand and balance.
In the current situation, where most major metro-markets across the US are going down, concessions are holding or propping up the prices. Once Concessions are deducted from the sale prices, the time adjustment becomes really apparent. All housing statistics, even those used by Shiller/Case, are propped up by concessions.
It is the job of the licensed professional appraiser to ferret out what needs adjusting for, eliminate fraudulent or phony sales, and reduce the comparable to a concession free, time adjusted piece of data. This is to be done Before the Locational and Physical Adjustments are made.
Not making a time adjustment or a concession adjustment could result in over inflated market value opinions, and increased liabilities. In most appraisal fraud cases we have worked on in the last 9-years, the appraiser went to better locations for the sales.
Location adjustments can be huge too. Within the same city or zip code there can be a 20% variance in location. In some instances, within a short distance, there can be that much of a difference or more. Not knowing locational boundaries (which is not a radius) can cause an appraiser to be off by more than 20% .
Assume every other adjustment made was spot on, so far in our example, an appraiser could be off 47.5% and not know it. Do you think that is true? Could a licensed professional be that unaware?
How do you think a jury might feel. One appraiser found out, he was indicted, sued, lost, appealed and lost. OK, so he was signing lots of reports on properties he never saw and knew nothing of this type of issue, but his case is fund to read. Take a look - click here - read the Expert Witness part too.
I reviewed the reports on this case before the Grand Jury Hearing and testified in front of the jury, with them asking questions for an hour afterward, including things like "Isn't appraisal more of an art than a science?" and me answering, "You don't need a license or Uniform Standards or Ethics or Competency to practice art." They got the picture and indicted six that day.
A proper Scope of Work in terms of the selection criteria might be a good thing to write into reports. Price is not a selection criteria, it is to be eliminated if one is to comply with USPAP.
Identifying the right location to search is important. Enumerating what the locational factor was and why it is important is a good thing to provide clarity to the reviewer or those who rely upon the appraisal. It also builds trust and adds to ones reputation of geographic competency.
Then, making market derived adjustments, in the right magnitude and sequence is a good thing for those with long term aspirations in this business. It adds to a reputation of product competency.
No one can tell you want to use for adjustments. If they do, it will probably be wrong. You, each of us ,needs to get to a "Knowing" before we make them or provide the proof or support.
Those who can analyze and support their Selection Criteria, Magnitude and Direction of the Adjustments will find a longer, richer and fuller life in the world of appraisal in the next 3-5 years. At least that is how I see it.
Our reports can be our best defense, or they can be used to hang us either in a civil or criminal case. The Definitions, Certifications, Processes and Procedures are all used against the appraiser in court.
Reports prepared for a court case might cost thousands of dollars, not a few hundreds. Unfortunately, the same standards apply, regardless of the fee, or how little time was allowed. Every wonder why they want appraisals back so fast? It might be so we don't have time to think. Think about it before you take your next out of area assignment.
AUTHOR: Steven R. Smith, MSREA, MAI, SRA, Smith Realty Advisors, Redlands, CA, Real Estate Appraisals, Consulting, Expert Testimony, Forensic Reviews, Fraud Research and Analysis, Litigation Support. All opinions expressed in this post are the author's and may not reflect those of the Appraisal Scoop blog.