Abstract

The popular sales comparison approach used by analysts to estimate value needs further clarification to show users and the public that professional judgment is applied in every step. Appraisers label this process as Reconciliation to assure that the best data is used and the analysis is meaningful relative to other value estimates.  Future data-driven markets will increase the demand for this value estimate based on larger quantities of quality data. Future analysts will need additional statistical tools and education to identify accurate market real estate trends. 

In a real estate market analysis of the future, artificial intelligence will bring new software capable of extensive market investigation with almost real-time data. The direct sales comparison approach will be examined in detail, as it will remain the most frequently used technique to estimate the market value of real estate. It is found and discussed in numerous sources on the internet and in educational material published by major real estate organizations such as the National Association of Realtors, Appraisal Institute, CCIM Institute, and Counselors of Real Estate.

Further, the motivation for additional transparency comes from three recent reports that have suggested that estimates of value in residential appraisals relying on this approach are subject to additional review due to a lack of objective procedure in the detailed analysis used by the analyst. One purpose here is to recommend a future action that can be taken by these organizations to improve the analysis of data and procedures involved and promote the understanding of this approach and acceptability. Additional transparency and acceptability of the sales comparison approach is critical to the real estate industry due to its universal use. Its popularity includes residential real estate agents, commercial and industrial analysts, appraisers, mortgage lenders, educators, and the general public.

One report released by the White House suggests the residential appraisals examined have lower value estimates reported in minority neighborhoods compared to higher values reported in neighborhoods with fewer minorities. Additionally, two recent academic publications found in respectable academic journals suggest that the commonly used sales comparison approach is flawed which creates an opportunity for a subjective result. If true, it means that this regularly used valuation methodology contains a procedure taught in real estate classes and utilized daily by this profession contains systemic inaccuracies, and needs to be reviewed.

Also, the authors in these academic publications using appraisals filed by U.S. appraisers in government-controlled portals as part of the loan approval process suggested that irregularities in value estimates came from the sales comparison approach.  The volume of filings and extent of the market coverage are significant and deserve attention by all valuation analysts due to the critical role this valuation approach maintains in the real estate profession.

The authors attempt to show statistically that this value approach allows subjectivity to enter the choice of calibrations applied by the analyst in three areas. The first is the criteria used to find comparable properties that best match the subject. The second is the choice of adjustments used to make the attribute of each comparable look like the subject, The third is the selection of weights used and applied to the adjusted estimate of value for each comparable to derive one final estimate of value for the subject.

The motivation for these two reports appears to originate from individuals who have asked for reasons that explain the difference between the contracted sales price and the estimate of value especially when a significant difference exists. An answer calls for a discussion on the relationship between the sales price and the appraisal, reasons for including the appraisal in the transaction, and the restrictions on the lender in certain types of loans. This discussion is not included here.   

The best source of answers that shed light on the calibration steps conducted by the analyst originates in the Reconciliation process that must be completed by certified licensed appraisers. In the general marketplace, Reconciliation is expected by all parties to the transaction to be like transactions conducted with the public by numerous licensed professionals such as accountants, financial planners, investment counselors, and medical service personnel.. Reconciliation and Professional Judgment become intertwined, and may be viewed as simultaneous evaluations when the final estimate of value is produced. 

Transparency information given to the public should include explanations that the three calibrations are all conducted on the best data available on a known date. To quote a slogan,” The data shows what it knows at a moment in time!” It is a cross-sectional picture that could be different on a different date. The Reconciliation step requires the analyst to review the quantity and quality of the best data available. Additionally, conclusions from the sales comparison analysis must be logical and meaningful relative to the conclusions from other approaches to value such as cost and income. 

Reconciliation of the sales comparison approach with the cost and income approaches is done continually in every step as the analysis progresses to a final value estimate. It includes a series of reconciliations reaching a final one at the end. It is not just one final step performed at the end. Thus, this process can be viewed as professional judgment under a different label. All licensees are expected to use professional judgment that the public willingly pays for. It is often used as a significant criterion for the selection of a particular analyst for a favorable reputation in the conduct of business.  At the end of the valuation process, both are used simultaneously and become one. Reconciliation is professional judgment, and vice-versa. The real estate licensee is considered competent to apply Reconciliation and Professional Judgment because the state has issued a license signaling sufficient education and experience.

The impact of artificial intelligence including its new software and a broader set of market data will create an increased demand for the analytical knowledge of real estate analysts. The expertise of the real estate firm has the opportunity to become the best data source in town. Accompanying the real data will be a need for expertise to explain the statistical results to the users. Future educational classes will be needed to provide the statistical knowledge contained in the data and its impact on the current market. The bottom line is that future analysts will need more educational opportunities to learn the answers to questions such as, “What does it mean if the mode in a data distribution of rents is higher than the mean and median? A straightforward answer can be found in the application of the Exploratory Data Analysis statistical tests that are loaded frequently on new computers or can be purchased at a reasonable cost.

As market data becomes more real-time with potentially a larger quantity of observations, analysts will need additional statistical skills. Additional questions will become more frequent such as “Are any outliers present? Do they exist in the lower number range, the upper range, or elsewhere? How many exist? Do they contain good information that adds to the estimate of value and should remain, or vice versa? Should two estimates of value be computed where one contains the outliers, and one does not?

More transparency information available to the public on Reconciliation and professional judgment, calibration analysis details using the best data available, and additional education for valuation analysts covering data analysis should provide a major advancement in communication and demand for future valuation services in a world of artificial intelligence.

References

“Biden-Harris Administration Takes Sweeping Action to Address Racial Bias in Home Valuations,” The White House, June 01, 2023, 3 pages.

“Uniform Standards of Professional Appraisal Practice Standards Rule 1-6, Reconciliation, 2024,” Appraisal Foundation, p.21.

Erickson, M.D., Fout, H.B., Palin, M., and Rosenblatt, Eric. “The influence of contract prices and relationship on appraisal bias,” Journal of Urban Economics, 111, 2019, 132-143.; Mayer, Y.G., and Nothaft, F.E., “Appraisal overvaluation: Evidence of price adjustment bias in sales comparisons,” Real Estate Economics, 50, 2022,862-881.