What is the purpose of the adjustment process?

This article was originally published in Appraisal Today, www.appraisaltoday.com. A hearty thank you to Ann O’Rourke

Some appraisals can take a narrow range of unadjusted sales prices, for example the range of $115,000 to $122,000, which is a spread of 6.09%, and through the process of analysis, it widens from $96,000 to more than $132,000 (spread of 37.5%). In case you think this is made up, it was a real world example, which spurred this short article,

This begs the question, if proper analysis of the units of comparison were applied, why would the range widen?

Sometimes it is due to the mechanical act of extracting adjustments from the market and putting them in the grid, without actually analyzing whether the adjustments extracted are actually valid. Alternatively, if there are a number of adjustments to be considered, do some of them weigh each other out? This means does the smaller house that is highly upgraded; possibly have more worth than the larger but dated house? If condition is not adequately accounted for, it is easy to see how the adjustments could make the dated house look more appealing, when in reality the market may well be more concerned with cosmetic condition than anything else. Because of the way buyers actually buy in the market place, it is critical that the appraiser step back from the process and look at the big picture to see if the value opinion ends up passing the curb test. The curb test is that of asking yourself, either whether you could see yourself paying that amount for the property, or if you would feel comfortable lending your own hard earned money for a buyer purchasing that property. If the answer is “heck yeah” then probably either it is too good a deal, or you are just that good. If the answer on the other hand is “heck no” then the value opinion is likely too high. Just right refers to that sweet spot where you consider that the price you would pay is fair to you as buyer, or lender, but also fair to the seller where it would be attractive enough to sell without any duress

What is the purpose of the adjustment process?

We make adjustments for the units of comparison that buyers recognize in the market, and through this process, narrow a range of unadjusted prices to something tighter, from which we reconcile. If for some reason the range actually broadens, there is a piece of the puzzle missing. This means we have to step back and reanalyze the processes and our adjustments; or perhaps even, our comparable choices. This is the very reason “bracketing” with a superior property and an inferior property is an important application. The unadjusted sales price of the inferior property sets the logical lower limit of expected value. The superior property also sets an upper limit of the expected value opinion. As soon as the appraised value is higher than superior, or lower than inferior, we know that there is something off in the analysis. If there are also similar properties to the subject included in the analysis, these become benchmarks for a generally expected value range.

Think of the way that buyers normally purchase property for a minute. Although there are some buyers who try to quantify everything, most do not. Most buyers simply like one house over another, and they do so because of location of the property, the site, the overall size, the flow/design, the condition and the amenities. Buyers will opt for the property that best meets their needs and is to their liking, for the most advantageous price. They will expect to pay less for a house that something that is superior to it and more than something inferior to it. Of course there are exceptions, such as the buyer who is under pressure to buy because they have sold their house and need to move, today. Or the buyer who wants to locate next to the grandchildren, or any other myriad reason that does not appear rational in the market as a whole. Often it is those very sales that throw off the appraisal in terms of widening the adjusted sales price range. Sellers also sometimes have undue motivations, which could cause them to sell at a lower price than expected, such as divorce, death, or other mitigating circumstances. Sometimes a seller will have an undisclosed sweetener, which might induce a buyer to pay more than expected, like that fancy new Mercedes that the buyer took a real fancy to that was parked in the garage of the otherwise vacant house. Verification of any unusual buyer circumstances with a party to the transaction is very important in this instance (it is in most, but when something is off in the adjusted range, this is often the best place to start reanalyzing). A conversation with the agent who sold the property will often uncover why the buyer paid what they did, such as the need to move, or even lately, having been outbid on so many prior offers that the buyer would simply have paid whatever necessary to buy the house.

Because houses are purchased and sold by humans, and humans do not always make rational decisions, understanding the “why” of a transaction can be critical. Because humans are making the purchasing decisions, it is important to understand what drives buyers to certain properties over others. Conversations with agents in the field are critical in understanding shifting buyer sentiments. So too is visiting builder models and seeing what the builders are installing in newly built properties. The builders are reacting to buyer desires and demands, and are a good source of information. Open Houses are also an excellent source of information, not only from the standpoint of seeing your future comparable sale, but also in listening to what buyers are saying while they are at the property, and talking with the agent if no one is there. A house with a much desired feature may sell for far more than others, and will skew the adjusted sales price range if the desired feature is not adequately analyzed or even isolated.

Market fluidity also affects sales prices. At times when there is an abundance, buyers have many options and can become very picky about features and condition of houses, and this will be shown in what they pay. Conversely, when the market is tight, and there is little to no inventory, buyers may pay far above what would be considered rational. This is one reason that we need to be aware of supply and demand.

After everything is considered and analyzed, there is no good rational reason for the unadjusted range of $115,000 to $122,000 to widen to the degree it did ($96,000 to $132,000). When this happens, step back from the process and ask what is missing. Pick up the phone and call the agents involved in the sales to get buyer motivations. Next time the adjusted sales price range widens, start asking if the various factors involved in the sales that were used in the appraisal report were adequately addressed –because through the very process of adjusting, the range should narrow, not widen.