Inferred Analysis
Inferred analysis is simply the use of historical market evidence or trends in the application of the six-step process. These analysis methods, which are described as Levels A and B in Table 2, identify trends and patterns and infer expected market behavior. This analysis includes the study of comparable sales for retail lot value estimates as well as the use of historical absorption trends as a basis for concluding market absorption. Essentially, inferred analysis describes most of the primary data collection and analysis efforts performed by the appraiser in a typical appraisal assignment. As applied in subdivision analysis and specifically the absorption estimate, inferred analysis usually involves the direct comparison of the subject project with the recent sales volume or absorption experience of competing subdivisions. This study can be done on a subdivision-specific level or on an overall macromarket level. The goal is to determine or estimate a market-supported absorption or sell-out period for the subject unit or lot inventory. The basic steps followed in inferred demand analysis are very similar to the steps used in the sales comparison approach for the selection and analysis of comparable sales.
The appraiser surveys the appropriate market area and selects a group of comparable subdivision projects to use for comparison purposes. These projects should be marketing lots in the same general price range as the subject project, have the same or similar marketing concept and project amenities, and have a history of market absorption or sales. Projects that have recently achieved full sell-out can also be used.
Next, the appraiser analyzes and quantifies the observed absorption pattern (e.g., lots per month) for each project, identifies market trends, and concludes market absorption for the subject product category. Then the appraiser determines if there are any additional features either in the comparable projects or the subject project that require consideration and makes appropriate adjustments in the absorption estimate for the subject project. For example, a comparable subdivision marketing homes at several different price points would probably support a different absorption level than a project with only one price point.
Then the appraiser considers the current demand and supply characteristics as they relate to past trends and comparable projects, reconciles market capture and absorption for the subject project, and forecasts the future absorption period. This would involve consideration of any new projects that may be coming in the near future and the timing of any future competition. Also, the absorption estimate may vary on a seasonal basis or in some other way during the sell-off period.
Inferred demand analysis tends to be the most accurate for projects with a relatively short absorption period (less than two to three years) and projects that are relatively small in comparison to the overall market. This type of analysis is especially accurate in stable markets with minimal fluctuations. The application of inferred analysis also relies heavily on current and relevant sales information
Fundamental Analysis
Fundamental demand analysis begins with inferred analysis but goes beyond the inferred trend analysis level by forecasting demand based on the segmentation of broad demographic and economic data to reflect the specific subject market. This market analysis follows the same six-step process and is described as a Level C or D study in Table 2.
Fundamental demand analysis tends to be most applicable to projects with relatively long absorption periods (greater than two to three years) and projects that are relatively large in comparison with the overall market. This type of analysis can be valuable in emerging markets that are driven by new population growth. Fundamental demand analysis relies heavily on accurate population and/or household growth data and, like inferred analysis, generally assumes that past patterns will be a determinant of future demand.
Inferred and fundamental demand methods are not separate, mutually exclusive techniques. Essentially, the fundamental methods are extensions of inferred demand analysis. A more detailed description of the six-step process and the levels of market analysis can be found in Market Analysis for Real Estate: Concepts and Applications in Valuation and Highest and Best Use. (1)
The results from both the inferred and fundamental demand methods are reconciled into a final absorption forecast for the subject project. An example of absorption forecasting using both the inferred and fundamental demand methods is presented in the following section.
Selecting the Appropriate Level of Analysis
The level of analysis to be employed in an appraisal depends on regulatory requirements, client needs, prevailing market conditions, property complexity, and whether the property is proposed or existing. The level of market analysis performed should match the level of information a client needs to reach a decision. This need is reviewed with the client as part of the scope of work criteria. The appraisal may be viewed as a service to help reduce (but not eliminate) risk for the client and the public. The greater the potential risk, the more intensive the level of analysis required. Regulatory requirements include the Uniform Standards of Professional Appraisal Practice, which requires sufficient market analysis in appraisals to support the use determination and the estimate of value.
In a market characterized by stability or equilibrium, a less intensive analysis may meet the needs of the client. A stable or balanced market usually exhibits three features: a steady number of sales in the recent past, the absence of overbuilding or a supply shortage, and available public studies documenting market equilibrium. If these conditions exist, a Level A or B analysis may be acceptable. Otherwise, the more detailed Level C and D fundamental methods should be employed.
The level of market analysis also varies with the type and size of the property. For an appraisal of an existing group of lots in a successful ongoing subdivision project with a recent history of sustained market absorption in a stable market, a Level A or B analysis may be appropriate. Risk is typically related to project size and the number of lots being appraised. Small projects or groups of lots usually have shorter marketing periods. Large projects or a large lot inventory will typically require a longer absorption time period and can be subject to more market and timing risks. A more detailed market analysis will be required with a minimum of a Level C market study.
Inferred demand analysis tends to be most accurate for relatively small projects with relatively short absorption periods (less than two to three years). This type of analysis is especially accurate in stable markets with minimal fluctuations. The application of inferred analysis also relies heavily on current, relevant sales information (see Tables 5, 6, and 7).
The most unique aspect of fundamental demand analysis is that it attempts to pinpoint where future demand will come from as well as its timing and quantity. Inferred analysis, on the other hand, generally surmises that all else being equal, future growth will follow the same pattern as historical trends. Both methods are important valuation tools.
