Real Estate Appraisals: Art or Science?
I sometimes jokingly remark to my wife, Erin, that “appraising is much like building a house or making sausage…you don’t always want to see how they’re made.” Like the imperfections hidden behind painted drywall in the building process or the spooning cuts of Italian sausage neatly presented at the meat counter…the final appraisal report is often the product of a messy process. Few people realize that there is no such thing as being unbiased. Without exception, everyone is biased. Everyone sees life from a unique perspective. The simple act of choosing which facts to present in an appraisal report IS bias. The best we can do is to recognize our biases and be aware of them when appraising real estate. Which brings me to the point of this post.
While most of us who love to crunch numbers would like to reduce the appraisal process to a scientific endeavor, it will never work. Why? Well, for a number of reasons. Among them are the inability to predict human behavior, the lack of information, sampling error, etc. I could give you more reasons. Instead, I’ll demonstrate my point. The scatter graph below plots the sales prices of over 900 home sales in Hardin County, KY, in chronological order.
Measuring Central Tendency
As shown in the graph, the prices appear to be quite random. That’s because they are very recent sales sorted only by chronological order. What happens during the appraisal process is that “comparable” sales are selected and adjusted for various factors to reflect the “most probable” price a buyer might pay for the property being appraised. Dealing with large volumes of data naturally lends itself to statistical analysis and in particular to regression analysis. So I ran a regression of these sales and developed a model to adjust each sale for differences with a given property. The results are shown in the graph below.
As you can see, the indicated price range has narrowed considerably. The central tendency appears to be somewhere between $300,000 and $400,000. In fact, applied to the subject property, the predicted price of the regression equation is around $354,000. However, as you can see, there is still a relatively wide range in potential values. Ideally, the property with the fewest differences with the subject property would yield the most accurate value indication. So I sorted these sales from the lowest to the highest gross adjustments. These results are presented in the graph below.
As you can see in the chart, there still appears to be considerable variation in price, even for the sales most like the subject property. In fact, here are the predicted prices of the ten most similar sales using the regression analysis.
Appraisals are BOTH Art and Science
The sales with the fewest adjustments still have a range of less than $300,000 to over $500,000 with an arithmetic mean of just over $400,000. An experienced and honest appraiser should know about where within this range the value should fall. But this still introduces bias into the equation. My only point is this: As you can see, statistics is a very useful tool for analyzing property. But it has its limitations. The first graph presented above is an excellent picture of the central tendency for this property. However, there is still a very wide range of indicated values using regression analysis.
There is still the unpredictable human factor…and the volume of data factor…and the inability to verify 900 sales factor to deal with. There will always be some degree of error, or uncertainty when dealing with appraising. That’s why appraising is as much art as it is science.