• Jesse Ledbetter

Approaches to Value: Subjectivity vs Objectivity

In every appraiser's toolbox there are three approaches to value that they reach for, the 1) Sales Comparison Approach, 2) Cost Approach, 3) Income Approach. There are objective and subjective factors to each. Sometimes appraisers overstate their case in an attempt to support one over another, but really all suffer the same weakness at their core: we're trying to measure what people do, and people approach things subjectively.

Sales Comparison Approach

It might be argued that the first page of the URAR 1004 is largely an objective document. Statements of fact about the property: acreage, zoning, GLA, but tied up in the midst of all of this are a large number of subjective evaluations: quality, condition, shape of the site, GLA itself has a subjective judgment involved as you decide if an area is of a sufficiently finished quality to be included in the GLA (per the FNMA selling guide). As we move to the sales grid, these subjective judgments begin to multiply. There is a reason why FNMA wants to see all amenities/features of the home bracketed - because they know that the SCA is really a qualitative analysis with quantitative figures. IF the SCA was truly quantitative, then there would be no need to bracket, adjustments would be absolute and justifiable, and any properties could be used. However, everyone knows that this is not the case, that the value is best derived and reported by having sales that sufficiently match or bracket all of the features of the subject. This doesn't mean that this subjective exercise can't come to an objective fact, a core principle of economics is that while a single individual may act foolishly, a sufficiently large group's median action will be rational. We can look at a sufficiently large group of people's actions and come to an objective understanding of market value. This is why I believe that the age of "three comps and a listing" is dead. With the exception of the simplest of reports, I intentionally include more than three sales to 1) bracket every amenity, 2) offer paired sales in the grid to support adjustments, 3) give the CU more properties to crunch to raise the overall score of the report and not get kicked back "why didn't you include X."

In every Sales Comparison Approach, the appraiser is making subjective, informed decisions based on objective, verifiable facts.

Cost Approach

This approach is most often espoused by supporters as being THE objective approach to value. Here are the reasons why that is not the case:

  1. Land value is derived by the sales comparison approach, which is subjective. If extraction/allocation are used, this is more subjective, as I'll lay out below.

  2. Effective Age (with the exception of new construction) is a subjective judgment. Coroners and medical examiners have "body farms" where human remains are left in various states to determine decomposition rates in various conditions (truly horrifying if you dwell on it too long). This is an objective, fact-based research. Appraisers, Marshall and Swift, and other cost guides have no such "house farm" where homes are left alone to decay over 50-70 years without maintenance. Any appraiser who argues that a home, unmaintained for 59 years will have 1 year of remaining economic life at the end is making a bold, and unsupportable statement. It is rather a subjective judgment. That subjective judgment, honed over hundreds of appraisals, may become a useful tool, but it will remain subjective. I'll give one simple and obvious reason why this is the case: Imagine the same home constructed in two places. One in the dry midwest, and the other in the extreme north country of Canada. Left alone, which will decay first? HUD knows that location matters to economic life, this why they rate manufactured homes for different areas... something that no cost manual takes into consideration.

  3. Cost of construction - I have a friend who is a general contractor in the commercial world. He bids on multiple jobs per week. The range of bids for construction ranges in excess of 15% in most cases. These are state-licensed builders, trained in performing cost analysis. Their sources of materials change their cost weekly, the weather dramatically changes schedules and costs. There are cost manuals that cost $30,000 per year for these individuals to use, and they can't get within 15% of each other on a cost?! Do you really think that your cost manual is keeping up with builder costs? Perhaps you have a few builders that you survey (when was the last time you saw a new construction go to the lowest of multiple bidders, reflecting an actual market exposure and competition?) - which end of the 15% range do you use? No - you make a subjective decision based on the best information you have available, because that's all the builder is doing, and that's all the buyer and seller are doing.

In every Cost Approach, the appraiser is making subjective, informed decisions based on objective, verifiable facts.

Income approach

The income approach has two subjective analyses within it - analysis of rent and analysis of Gross Rent Multipliers. These will nearly always present a range of values that the appraiser must then choose from. Again, this is not an uniformed choice, but it is a subjective choice. Of all of the rentals available, does the subject fall on the high or low end of appeal. Of all of the GRMs calculated from the sales, does the high/low end represent the appeal of the subject.

In every Income Approach, the appraiser is making subjective, informed decisions based on objective, verifiable facts.

This is why the movement to more and more automation in the Real Estate industry should concern everyone involved. There is no approach to value that does not have a subjective element - and to date - no algorithm has been able to perform such a calculation as "what effect does olive green wallpaper have on the buyer pool response?" That remains the domain of human beings. However, with the reinvention of the UAD Reporting, it appears that Fannie Mae wants to quantify the subjective more and more. The results will likely be more revisions to consider "this other sale."

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