http://www.boe.ca.gov/proptaxes/pdf/ah502.pdf
Start on Page 46 (although it's best to read all of it first)
ESTIMATING ADJUSTMENT AMOUNTS
Several quantitative techniques can be used to estimate adjustment amounts. Recognized
techniques discussed below include the following:46
· Paired sales analysis · Capitalization of rent difference (gain or loss)
· Statistical analysis · Discounting and time value of money concepts
· Cost analysis
PAIRED SALES ANALYSIS
Paired sales analysis is perhaps the most common method for estimating adjustments. The
technique requires sales properties that are identical in all characteristics except the
characteristic, or element of comparison, that is being measured. Alternatively, and less reliably,
if the sold properties differ in more than one characteristic, adjustments must already have been
made for characteristics other than the one being measured. The adjustment is estimated by
simply subtracting one sale price from the other. In theory, paired sale analysis can be used to
estimate the adjustment for any element of comparison, provided sufficient data are available.
Paired sales analysis is a popular technique for estimating the market conditions adjustment.
Sales and resales of the same property or of highly similar properties are required. To make the
adjustment, the appraiser should: (1) list the sales, (2) calculate the percentage change between
the sale and resale prices, (3) divide this percentage change by the number of months between
sales dates, and (4) apply this monthly estimate of the change in market conditions to comparable
properties.
Paired sales analysis is also used for estimating adjustments for differences in physical
characteristics. The paired sales must have occurred at the same time or have been adjusted for
market conditions. To estimate an adjustment for physical characteristics, the appraiser first
selects a sale property with a given set of characteristics. This sale property is then paired with
another sale property (or properties) identical in all characteristics, except the one whose value is
being estimated. The sale price of the first property is subtracted from the sale price of the second
property in order to obtain an estimate of the value of the isolated characteristic.
In theory, paired sale analysis is a sound analytical technique. However, often there is an
insufficient number of applicable paired sales—especially in the case of commercial properties.
In addition, an estimated adjustment amount derived from only a single pair of sales may not be
valid. However, when there are sufficient market data to apply the technique, paired sales
analysis is practical and useful.
46 In addition to quantitative techniques of adjustment, some appraisal texts discuss qualitative techniques.
Qualitative techniques compare comparable properties with the subject property by ranking them as "superior" or
"inferior" (or similar terms) to the subject; adjustments not explicitly stated as either lump-sum dollar amounts or
percentages. The subject property is then placed within the qualitatively ranked array of comparable sales in order to
estimate its value. Appraisers often refer to this as "bracketing" the subject property. While this may be a widely
used and valid appraisal technique, it is not in accord with provisions of Rule 4. Also, see footnote 34.
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STATISTICAL ANALYSIS
Statistical techniques (e.g., linear and multiple regression) can be used in the measurement of
adjustments. If an adequate database of sales data is available, multiple regression analysis is a
valid technique for estimating the contributory value of selected elements of comparison that
does not require the strict similarity between parcels required in most other methods of
estimating adjustments. Using multiple regression analysis for this purpose involves the same
methodology as valuation models based on multiple regression. A discussion of this technique is
beyond the scope of this manual.47
COST ANALYSIS
An appraiser can use a cost analysis to estimate adjustment amounts, particularly for physical
characteristics. Cost indicators such as an estimate of replacement or reproduction cost less
estimated depreciation, an estimate of cost to cure, an estimate of deferred maintenance, etc., are
used as the basis for adjustments in cost analysis. Although this method is widely used, its
shortcoming is that the adjustment is not market derived—that is, estimated cost may or may not
equal fair market value.
CAPITALIZATION OF RENT DIFFERENCE
Differences in rent (either a gain or loss) due to a specific property characteristic may be
capitalized into an estimate of an adjustment amount. This technique is typically used to make
adjustments for differences in physical characteristics, although it can be used for any difference
between properties for which a permanent rent difference can be estimated. Obviously, an
estimated capitalization rate is also required. For example, the subject property may have an
elevator while a comparable property does not. Using market rental data, a rent differential for
the two properties is estimated and capitalized—using direct capitalization—into an estimate of
the adjustment. Both the rent difference and the capitalization rate should be market supported.
DISCOUNTING AND TIME VALUE OF MONEY CONCEPTS
An adjustment for above- or below-market leases (a property rights adjustment) can be estimated
by discounting the difference between market and contract rent over the remaining term of the
lease into a present value estimate. This technique requires an estimate of both the difference
between market and contract rent and an appropriate discount rate. For example, assume that the
sale price of a comparable property reflects a contract rent that is above market and that the lease
has a remaining term of five years. A lump-sum adjustment is estimated by discounting the
difference between contract and market rent at a market-derived discount rate over the five-year
period.
An adjustment for non-market financing (a cash equivalent adjustment) can be estimated using
discounting and time value of money concepts. Essentially, this technique involves discounting
the periodic payment of the non-market loan into a cash equivalent, present value amount. The
47 See International Association of Assessing Officers, Property Appraisal and Assessment Administration,
(Chicago: International Association of Assessing Officers, 1990), 159 and chapter 14.
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payments are discounted at the market interest rate over either the remaining term of the loan or a
shorter assumed holding period.48
ADJUSTMENT PROCESSES AND METHODS
As noted above, adjustments are made to the comparable sales prices to account for differences
between the comparable properties and the subject property. The final result is a set of adjusted
comparable sales prices representing estimates of what the comparable properties would have
sold for had they possessed all of the important characteristics of the subject property. The
adjusted sales prices thus become value indicators for the subject property. The process by which
adjustments are made is sometimes referred to as "comparative analysis." This process involves
several considerations, which include: (1) the direction and sign of adjustments; (2) the sequence
of adjustments; (3) whether adjustments should be made in lump-sum dollar amounts or
percentages; and, (4) whether adjustments should be made to the total property sale price or to a
unit of comparison.
Direction and Sign of Adjustments
Adjustments to a comparable sale price are made toward, or relative to, the subject property.
When a characteristic of a comparable property is inferior to that of the subject property, the
adjustment to the comparable sale price is positive (i.e., the adjustment amount is added to the
comparable sale price). When a characteristic of a comparable property is superior to that of the
subject property, the adjustment to the comparable sale price is negative (i.e., the adjustment
amount is deducted from the comparable sale price). This procedure applies to both lump-sum
dollar adjustments and to percentage adjustments.
Adjustment to Total Sale Price or Unit of Comparison
Adjustments can be made to a total sale price, an appropriate unit of comparison, or both.
Sometimes, adjustments are made to the total sale price for property rights conveyed, market
conditions, cash equivalence, and non-real property items. This adjusted sale price is then
converted into a unit of comparison (per square foot, per unit, per acre, etc.) that is further
adjusted for the remaining elements of comparison (i.e., location, use, and physical and economic
characteristics). Alternatively, all adjustments can be made to the entire property first, then this
adjusted sale price can be divided by the relevant unit to derive a unit of comparison. The second
method is more direct and preferable.
Lump Sum or Percentage Adjustments
Adjustments can be made as lump-sum dollar amounts or as percentage amounts. A general
principle regarding adjustments is that they should be applied in the adjustment process based on
the manner in which they were derived. Since most adjustments are derived in the form of dollar
amounts (exceptions are the market conditions, i.e., time adjustment and perhaps the location
adjustment), this leads to a general preference for dollar adjustments. Further, the particular
48 See Assessors’ Handbook Section 503, Cash Equivalent Analysis.
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sequence is not significant in the case of dollar adjustments, which is not always the case with
percentage adjustments.
If multiple percentage adjustments are used, they can sometimes be applied in either an additive
or multiplicative manner, producing different net adjustment amounts. "Additive" simply means
that the percentages are added to arrive at a net percentage adjustment. "Multiplicative" means
that the percentages are multiplied to arrive at a net percentage adjustment. A multiplicative
adjustment implies that the factors considered in the adjustment process are causally related and
hence correlated with each other. Multiplicative percentage adjustments should not be used
unless this correlation can be verified, which is not often the case.
