Is There a Fourth Approach to Real Estate Value?
I want to talk to you about the fourth approach to value…
…and specifically an occasion on which it truly saved my bacon.
Now, I know a lot of you real estate appraisers out there probably started chuckling as soon as you read the words ‘fourth approach to value.’ If you did, I get it, believe me! I used to be the same way. Over time, however, I’ve grown to see how it can often be a vital part of the valuation process.
Let’s have a quick recap for anyone who’s either forgotten the fourth approach, or never learned it to start with. You have your three traditional approaches: market, cost and income. The ‘fourth approach’ is basically like sitting on the curb across the street from your subject, after carrying out the inspection and asking yourself, “Well, what the hell would I pay for this thing?!”
It’s not the most… scientific approach, obviously. I would argue, however, that real estate appraisal isn’t an exact science anyway. Hold the flaming tomatoes. Hear me out! You have the cold, hard facts, sure – the math, the stats, your informed judgment – but when it comes down to it real estate appraisal is an art form. Sometimes it boils down to what you feel inside; what’s in your gut. That doesn’t mean you can just go around placing whatever value you please on every property, but a gut check can be vital to reaching the correct valuation.
I had an experience recently, which was what originally got me thinking about this. I was on my way to appraise a property, which had originally been designated as a single-family, before my assistant and I worked out that it was really a multi-family. Sure enough, on arrival, it was a detached, multi-family, fourplex: a single family home in the front, with three apartments in the back.
In my experience with properties in my area, nine out of ten times the highest and best use is multi-family (when you have the choice). After the property inspection, I got back to my office and got to work. I used good comps and good adjustments, all the while having the highest and best use as a multi-family (I know, before you say it, that that’s the first thing you’re supposed to do; I admit to and talk about my mistakes so that you can learn from them). Finally, I got to the reconciliation, and the value for the property – bear in mind that this was a nice, big house – and the number that came out was way, way off.
I applied the fourth approach to value. I said to myself, “Dustin, would you pay $X for this house?” The answer was a big, fat ‘no.’ To cut a long story short, I found out what the problem was, rectified it, and came up with a much more accurate valuation. If I’d never taken the time to evaluate objectively – if I’d simply accepted that initial value – I could have been in big trouble.
That’s what the fourth approach to value is all about: giving yourself the opportunity and the time to take that step back and look into your gut. Learn to trust your instincts as a real estate appraiser. Trust what you feel inside, then go back and find good, relevant data to support (or not) your inclination.
For more information on this subject, please download and listen to The Appraiser Coach Podcast Episode 023 – The Fourth Approach to Value