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 fourth approach to valueapproach 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

22 thoughts on “Is There a Fourth Approach to Real Estate Value?”

  1. Pingback: Is There a Fourth Approach to Real Estate Value? - Appraisal Buzz

  2. I have been teaching appraisers the Fourth Approach to Value for years… I sometimes re-phrase to its your money you are spending to purchase lending…

    1. I have been teaching appraisers the Fourth Approach to Value for years… I sometimes re-phrase to its your money you are spending to purchase lending…

  3. The 4th approach to value is really, in essence, the first approach to value. We need to put on our appraiser hat and ask ourselves, at the end of every report , “Does this make sense?” If it doesn’t and if you don’t feel like you can send the report in with the value on page 2, you have more work to do.

  4. Jackie Allison

    Thank you for highlighting this and Amen to what Bill said. Unfortunately the underwriters/reviewers are looking at their checklist and want to know why you didn’t bracket the extra 10×10 patio that the $500,000 subject had… Like that would be a make-or-break component of the appraisal. Without this approach, our appraisals wouldn’t be needed and they could just use automated valuations.

  5. When I first started appraising back in the 1970s the first firm I worked with the owner used to say after all the mumbo jumbo go sit on the curb and decide what it’s really worth. Not a new idea but one to remember

  6. Yes, this process something I have personally done for over 30 years and it is an essential component of the appraisal process. However, I strongly disagree with labeling the process as a Fourth Approach which is an inaccurate and misleading term in relation to the Three Approaches to Value. What you are labeling as a Fourth Approach to Value is the key part of the reconciliation process of the Approaches in reaching a final value conclusion. I agree, if at the end an Appraiser is not personally buying off on the indications from the Approaches, it’s time to take another look to find out why.

  7. Great thoughts Dustin. I agree with Kathrine, it’s not an approach, but more of a thought or a smell test that should be done in reconciliation. However, I caution that it is hard to test from a standpoint of, “Dustin, would you pay $X for this house?” This is because, as the appraiser, we are not an interested buyer. For example, if our hobbies involve travel, we might not value a house with a work shop as much as the probable buyer who has a welding hobby. What I do is test from a standpoint of asking myself if the subject is overall superior or inferior than each of the comparable sales from the standpoint of the typical buyer. Key here is putting yourself in the shoes of the buyer. Does my value make sense in these simple terms?

  8. Most buyers of homes today buy monthly payments, the price of the property is sometimes not that important to them, That might be why our simple subjective view of “would I pay this for that” is disconnected from their reality; but relevant.

  9. Call it what you want. The fact is you have to ask yourself “does it make sense?” and would the typical buyer pay that for it. You can not waste time trying to analyze individual buyer’s possible hobbies motives etc. . . It boils down to “would I pay this for it?” or “does it make sense?” The point is if your gut tells you something, then take a second look and make sure you are completely comfortable with the results. It’s your rep, license, integrity, and E & O.

  10. I am a broker as well as an appraiser. After I finish an appraisal I ask myself, would I recommend a buyer to purchase this property at the appraised value. It is a good check.

  11. joyce d Conner

    It’s so nice to see an article written about the most important skill, we as appraisers have. I almost feel like I have to keep this approach a “secret” because it’s not concluded by dividing this number by that number, etc. Of course I do the number game on all my appraisals but my gut is the one skill that I think makes me a great appraiser. That being said, it seems like underwriters, lenders, etc. don’t accept that anymore. They don’t trust my “gut”. They want hard numbers that can be reproduced at a desk, 1,000 miles away! Thank you for reassuring me that I’m not the only appraiser that still uses her gut!

  12. Martin Winfree

    The legendary Dave Montana (who was in the profession a little before my time) had a similar approach in valuation. He said that after preparing your appraisal report and doing all of the approaches the best way you know how, you should sit on the sidewalk across from the property and say to yourself, “What would this property really sell for”? The pose would be very much like the one at the top of this page.

  13. My first mentor taught me the 4th approach and it has served me well over the years. I thank ole Jim G. for that lesson as he is now in heaven probably doing appraisal reviews and playing golf 3 X each week.

  14. R. J. Kirchner, SRA

    Beware of the appraiser who states real estate appraisal is an art and not a science. The moment it becomes an art, it becomes bias. Truly credible measurements of market value allow the data to point to the measurement of value, rather than allowing personal feelings enter into the measurement. If you always think of the valuation as a measurement based upon factual data, your valuation measurements will remain truly unbiased and professional. The moment the practice becomes something controlled by how you feel, the answer no longer is an unbiased measurement based upon facts. Those of you who are teaching appraisers to follow this type of feels good valuation techniques should be ashamed of yourself and should re-read USPAP and the certification requirements entailed therein.

  15. I was taught this very thing in my early appraisal courses. It’s a great check against your conclusions. In cases where a property is under contract and that contract meets the criteria set forth in the definition of market value, using the contract price as a value indication is also a reliable “approach”.

  16. Debora Pietrella

    I can not believe the above comment. You should never use the contract price as an indication of value. An appraiser can not take for granted the buyer is informed or familiar with the local market and the realtor has skin in the game. As an appraiser you are paid to be the eyes of the lender and determine the true market value of the subject property. In completing an appraisal for a purchase you not only protect the lender but, also the buyer.

  17. William A. McCann

    I’ve always know there are 4 approaches to value. Cost, Market, Income and ask the man (or woman) who knows!

  18. Great topic, Dustin, and for those of us who’ve been around for a “few” market cycles, and learned the craft “pre-licensing” (I was on the cusp), we often pointed out that this is an art, not a science! This is the hook finally that we have to hang our hats on ultimately in the fight, if you will, with the powers that be in the efforts of lenders to rid the process of our services. This “fourth approach” is integral to this profession, and why I cringe when I see all the scientific approaches to what we do be put to the fore, not that they do not have validity but because when you take the personal out of the process, I think we shortchange the analysis, and ultimately we too are people in the marketplace, albeit more “educated” in the arena, but nonetheless almost the objective eyes in the market. Who else is more-so? I actually like the term “fourth approach” because it identifies the relevance of our educated opinions in a world where statistics are almost thought more of than the “reaction” of the typical buyer. This doesn’t put this approach above the other 3 at all. It’s not technical, it doesn’t sound fancy, like some of the techies out there want it to be but it’s integral.

    Incidentally, if we continue to push statistical analysis to its nth degree, taking out our fourth approach, we are justifying the use of these tools to de-legitimize our very own existence; it’s already happening, but that’s another topic.

  19. Interesting topic and responses. I would agree with those who have stated that what you are really referring to is reconciliation. USPAP says we must reconcile all methods and data; I wonder how many actually consider what that means on each assignment. For instance one poster here stated that appraisal is not an art and rather a science and then went on to state how we should all go back and read USPAP if we think otherwise. I find that perspective amusing and horrifying at the same time. If we really take an honest look at what we do (reconcile), scientifically, we should all be coming up with a similar conclusion, which is that the data only takes it so far. When tasked with defining value as a single price, rather than a range of value, it is impossible to “calculate” to that degree of refinement, at least credibly, at least in a manner an actual scientist would not laugh at or at the very least, conclude the results are inconclusive, due to a lack of applicable data to apply to the task at hand. Therefore, IMHO, unless an appraiser is extremely stupid, sloppy or unethical, applying a good dose of appraiser judgement is the only way to credibly define a value as a single price, no matter what credential follows their name. Garbage in garbage out.

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