This is the forth article in a five-part series dealing with the new 1004MC form (MCF) by David Braun, MAI, SRA. In Part 1 of this series, David began with a discussion of where appraisers are NOW . . .and gave some direction on where we're headed. In Part 2, David looks at appraiser's frustration with the 1004MC and in Part 3, he gave us a "What Goes Where and Why" look at the 1004MC.

I am enthusiastic about appraisers gathering large amounts of data onto a spreadsheet for analysis. The power gained from the appraiser being enlightened through this process is staggering. I am on record for supporting Fannie Mae in the over-all process, and condemning the appraisal profession for not beating Fannie to the punch. I believe strongly that the form (not the process) is far too limited.

The Total Solution program that I developed is an example of adding to and expanding a standardized form. Performing a market condition analysis is a lot like sky diving in the sense that you either do it or you do not.

Many critics are correct when they say, “Appraisers are providing misleading market condition analysis.”

I agree that many appraisers are limiting their data and scope of work to such a degree that the results and conclusions are just not reliable. **Appraisers are much more like the Wright Brothers at Kitty Hawk, than the modern-day jet pilot . . .but we have to start somewhere.**

In this part of “The 1004MC-71 INDUSTRY UPDATE” the process of extracting the appropriate market conditions (time) adjustment for the direct comparison grid and determining the value trend’s direction (stable, increasing, declining) will be addressed.

This method is appropriate for vacant land, apartments, and various commercial properties. Microsoft Excel is the canvas used in the following adjustment extraction process.

The examples are taken from AVT’s Market Conditions Adjustment Extractor. You can view it and other automated appraiser tools at http://www.scoopgear.com/automated-valuation-techn.html

**The market conditions extraction process has the following steps:**

1. Gather the appropriate sales data.

a. Perform an MLS search

b. Return the search query to an spreadsheet

2. Analyze the data based on some sort of value per unit.

a. Unadjusted sales price per property

b. Sales price per square foot

c. Fully adjusted sales price

d. Apartments might be per unit

e. Condominiums might be per bedroom

3. Plot the date of sale and the appropriate unit of comparison as on a “scatter” chart.

4. Insert the appropriate trend line into the plotted points.

5. Compare the X and Y points for the effective date of the appraisal and the comparable sales date on the trend line. a. Manually with a ruler b. Mathematically by solving the equation

6. Calculate the percentage difference in the two value units (Y-axis).

7. Apply the percentage difference to the comparable sales price.

8. Adjust the sales price by the difference found in step 7 above.

Most appraisers have been exercising Steps 1 and 2; so there will be no discussion here. Some appraisers have had access to applications such as the Total Solution or others applications that construct the scatter chart for you when performing a MCA. Those of you who do not use one of these automated systems can download an Excel workbook and instruction manual from www.alamode.com/labs that will aid you in this process. The workbook is preprogrammed to help you make a number of useful charts.

The sales prices per square foot are on the Y-axis, while time is plotted on the X-axis. Each sale is plotted as a “dot” on the scatter chart. It is apparent where the scatter chart got its name. The trend line was placed by Excel based on regression and was fitted to have the summation of the least square of the differences in each point and the trend line.

The data does not seem to fit a straight line very well as value tends to move upwards for a while and then top out around October 2008. Values appear to fall from that point on. This can be seen in the following chart. The red colored trend line appears to fit the data much better. The trend line in this chart is based on a polynomial line. Polynomial lines are appropriate when the value trend changes direction or is curved. The value trend presented in this chart is not conducive to the MC adjustment formula that appraisers traditionally use such as adjusting the sales price upward at a consistent specific rate per year.

In the chart above the effective date of the sale is 4/1/09 and the sale sold for $200,000 on 4/1/08.

**Exercise 1:** Based on the data presented what is adjustment should be made to the sale? (A) Based on a straight line analysis, and (B) based on the polynomial curve presented.

The purple dotted lines represent the various intersections. Lines 1 and 4 represent the effective date of the appraisal and the comparable’s sale date respectively. The straight regression line intersects Line 4 (Sale Date) at $118.02 and Line 1 (Efft Date) at $134.07. This indicates an appreciation rate of 13.6% ($134.07 - $118.02) / $118.02.

The polynomial regression line intersects Line 4 (Sale Date) at $103.93 and Line 1 (Efft Date) at $105.36. This indicates an appreciation rate of 1.37% ($105.36 - $103.93) / $103.93.

On a $200,000 property the difference between these two methods is $24,460 (13.6%-1.37%) x $200,000. This is a significant error.

**Exercise 2:** Using the same data find the appropriate market condition adjustment for a comparable sale which sold for $200,000 on 11/1/08 with an effective date of the appraisal of 4/1/09. Find the appropriate adjustment for a straight regression line and one based on the polynomial regression line. Use the ruler method and see if you agree the answers the MC Adjustment extractor calculated.

**Exercise 3:** What is the current directional trend of the market?

**Answer:** Declining

In this case the value trends are definitely declining. What are the factors that should be considered in forming a conclusion about the direction (stable, increasing, declining) of the value trend.

First, the appraiser must decide if they are keying on a regression trend line or the actual trend of the median sales prices per period. Then the appraiser must look for some percentage change over some period of time.

There is no one accepted definition; and logically, this task requires a definition. Any definition will have to consider a specific time period, but much like exposure time it may be different for each sub-market. This is because we want to make the determination based on the intermediate term trend, and not the normal cyclical movements around the long term trend.

The short-term cyclical movement can be based on seasonal influences, but are basically caused by the market going in and out of balance. This represents the normal changes in supply and demand that all markets experience. This means that the direction of the intermediate term trend can only be measured over a time period that is longer than the normal short-term cycle for each particular market.

It is the inability of the market to correct itself through the principle of market equilibrium that indicates the direction of the over-all market value trend from stable to increasing or declining. Once the market is out of balance in terms of supply and demand, and it is able at achieve balance by the principle of market equilibrium then the market will have achieved a stable valuation trend. In theory, the time period would be market specific based on the frequency of the short term cycles. The percentage change in the median values or regression trend line that represent a change in direction of values in the market is determined by the sub-markets natural cycle size.

The above chart shows a market that cycles up and down with about a 6% fluctuation in values (from high to low). This is a hypothetical situation, but probably typical for many residential markets.

Many people originally thought that a change from 1% to 3% in the median prices tracked over time was significant. My studies and analysis lead me to believe that a sensitivity level of 10% to 15% is more realistic when measuring changes in the median sales prices over time. However, a much lower change in the trend line may be a legitimate indication of a change in the value trend’s direction.

The proper sensitivity level to indicate a change in value when looking at a trend of the median sales prices over time depends on how wide the short-term cycles are. The chart below represents real market data. The normal short-term cycle is illustrated by the red (solid) line. The median sales prices per period are osculating around the trend line (Blue solid line).

Most of the data points do not fall exactly on the trend line so the sensitivity levels used for the data points (median values) should be different than for the trend line.

A declining market is indicated when the over-all trend in values based on a polynomial trend line falls by one half of the normal full cycle variance over a time period equal to the normal frequency of one cycle for the market in question.

The above market then would indicate a decline in values when the polynomial trend line falls at least 4% over a six month period. The percentage change when tracking the medium sales prices directly would have to be >4% when measured from the bottom of the cycle and >12% when measured from the top of the cycle.

Some “more” practical benchmarks are needed by appraisers, reviewers, and underwriters. A market trend determination should be based on a 12 month period with heavy weight given to the most recent 3 months. A sensitivity level of 12%-15% changes in a direct trending (not the regression based trend line) of the median sales prices over time is typical of most residential sub-markets. A 3% change in the regression trend line based on a polynomial curve to the 3rd power is a good benchmark for an indication that the market has experienced a change in value trends. These bench marks should be tempered considering all of the other market indicators.

**Conclusion:** When the data points indicate a change in direction or strong curve then a straight-line trend line analysis is inappropriate. It is very adequate for the appraiser to simply apply a straight edge ruler to a chart that has a trend line and do the calculations by hand for each sale. However, for maximum efficiency (appraiser’s time) and accuracy computer programs such as AVT’s “Market Conditions Adjustment Extractor” can be used.

The call made by the appraiser on the trend of values in a particular sub-market is determined by the time period considered and the sensitivity of the percent change in value that constitutes a change in the intermediate value trend. This is based on the normal value cycles of a market discussed above and the accuracy of the appraiser’s measurements of these changes that will be covered in Part 5 of this series. While the time period is related to the normal frequency of cycles for the specific market it is difficult to determine any conclusive pattern in less than six to twelve months. There is a balance between having timely information (based on short time periods) versus having a comfortable degree of reliability in the opinions and conclusions put forth by the appraiser..

**Be on the lookout for Part 5; “STATISTICALLY SIGNIFICANT” AND “EXPECTED VARIANCE”.** In Part 5 we will discuss how reliable the market condition adjustments put forth for the adjustment grid, and the indicated direction of the value trend (stable, increasing, declining) are when a trend-line analysis is used.

**Author: David A. Braun, MAI, SRA** (President, Braun & Associates, Inc.) has been actively engaged in real estate appraisal, review, and consulting since 1976. David is also the author of **Appraising in the New Millennium - Due Diligence & Scope of Work, 3rd Ed.****All** of his products can be found on http://www.scoopgear.com/automated-valuation-techn.html

## Recent Comments