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Whats Your Number?

Bryan S. Reynolds

The pioneers in our business—developers and early practitioners of the dark-art/science of valuation theory—intended for our discipline to be recognized as one of the professions, like law or accounting. Frederick Babcock, who is considered the pioneer of appraisal theory, wrote this in his book, The Appraisal of Real Estate,published in 1924:

The appraising of real estate is a business to-day. There is, however, a decided tendency for real estate evaluation to become distinctly professional, and it is probable that in a short time real estate appraising will be recognized as a profession as truly as any other.

More than a short time has elapsed since 1924, but I fear that Babcock’s forecast has not yet come to pass; we still have a ways to go to meet that goal.

What’s Your Number?

When you appraise an average home in your market, what’s a standard estimate of the house’s total economic life? I’ve asked this question of appraisers around the country for years now, and I get a variety of answers, from 30 to 100 and everywhere in between.  Others respond by simply saying, “It’s not in the report.” I’d argue that it should be in the report, and in a sense, it is. The information is all there; you just need to take the final step: Add effective age and remaining economic life, and you get a sum—which equals total economic life.

Really, the answer itself isn’t the most important thing. What matters is how you got that answer.

Where Did You Get That Number?

The important question for appraisers is this: Where did you get your number? Or what support do you have for that number?

Most Common Responses from Appraisers

  • My Supervisor
  • Their Supervisor
  • Guessed
  • Plucked It From Air
  • What My Peers Are Doing
  • That’s Just My Opinion
  • Years of Experience

The comment section of Standard Rule 1-3 of USPAP states:

An appraiser must avoid making an unsupported assumption or premise about market area trends, effective age, and remaining life.

These responses are “unsupported assumptions,” nothing more.

I’m always amazed when I question an appraiser or assessor who is a witness in a formal hearing, and they cite “years of experience” to support their conclusions. This line just doesn’t cut it anymore. What if, when you were a trainee decades ago, your supervisor taught you an improper technique? You’ve been using this same protocol for 20 years, assuming it’s a good methodology. Wouldn’t you be an expert at using an improper technique by this time? You’d have “years of experience” doing something wrong, wouldn’t you?

Recognized Technique

Let’s review a recognized technique to support an opinion of total economic life. Before we start the math we need to review depreciation.

Here’s how the Dictionary of Real Estate Appraisal, published by The Appraisal Institute, defines depreciation:

In appraising, a loss in property value from any cause; the difference between the reproduction or replacement cost of an improvement on the effective date of the appraisal and the market value of the improvement on the same date

While I believe the first part of that definition should be changed, as depreciation is not always a loss in property value from any cause, the rest of that definition is spot on. I’ll get into that in more detail in another article, but just think for a minute: How can you lose something you never had in the first place?

Here’s another workable definition of depreciation, from page 230 of The Appraisal of Real Estate, by Frederick Morrison Babcock:

“Accrued depreciation is the difference between the cost of reproducing the building new and its present-day value.”

Keep in mind that understanding depreciation is as simple as this formula: Cost minus value equals depreciation.

But before we analyze a sample sale, it’s important to understand the need to review several comparable sales and reconcile your findings. How often do you need to conduct this market research and analysis? Every time you do an appraisal? Of course not. Every month? No. What about every time you do your paired sales analysis? Maybe a little more often than that.

It’s your judgment call. Maybe you conduct this research and analysis once a year, or twice a year. Maybe you do it whenever you feel that the market has changed enough to warrant a new analysis. However you decide how often to revisit your research, do revisit it. It’s what professionals do.

Now, let’s take a look at the math:

$125,000          Sale Price

-$ 25,000         Land Value (Land Value and Depreciated Site Improvements)

$100,000          Implied Value of Improvement

$115,000         Cost New

         -$100,000         Improvement Value

$ 15,000          Depreciation

$15,000    ÷      7       =       $2,143

Dep               Age           Annual Dep.

$115,000          ÷      $2,143      =   54

Cost                         Dep             TEL

Reconciliation

Anytime I’m talking with a statistician, I ask how many of a sampling or data set do I need for sound results. I have heard answers as varied as 100, 60, and 31, so I suggest you analyze several sales.

Of course, you’ll get different answers to the question of total economic life. The point is to hone your analytical skills and methodology so that whatever answer you get, you can offer strong reasoning to support it.

Your judgment is the sharpest tool in your appraiser’s toolbox. You should reconcile your findings to an opinion of total economic life and, by the way, you also just obtained support for a condition or effective age adjustment. So the next time someone asks you, “Where did you get your number?” you can respond, “From the market.”?

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