What is “Valuation Engineering”

by Bert Craytor, SRA, CGREA, Software Architect

The term “Valuation Engineering” is intended to denote the application of a broad range of techniques and tools for measurement and valuation for real estate, business and government purposes.   It may be regarded as the “Elephant in the Room”, as it incorporates several other disciplines and a broad range of training, experience and ability.

• Note:  The term “Measurement Engineering” more aptly applies to hardware engineering problems involving very precise measurement.  Here it is used in the sense of Hubbard Decision Research’s (HDR) Applied Information Economics (AIE) framework, which involves calibration and advanced statistical techniques to measure intangibles often considered unmeasurable. 

In fact, “valuation” is just the measurement of value.  At the same time, valuation invariably depends on sundry measurements of entities, processes and characteristics.   For example, the value of a home will invariably depend on a reasonable measurement of its building area, which will include the  “Gross Living Area”,  garage and other areas.

To define the term “Valuation Engineer” let as first define the major professions that overlap with valuation engineering:

Appraiser

In the US, the term “appraiser” has a specific meaning that encompasses rather specific methodologies for appraising property.   To become a licensed appraiser in the United States,  minimal requirements do not include a degree in statistics, let alone science or any other discipline.    In fact, rather minimal expertise is required to provide what are considered acceptable opinions of value for many “conforming” residential properties.    If an appraiser feels that a property is too complex or difficult to handle, he simply turns down the order request.

Surveyor

In the UK, appraisers are appropriately referred to as “surveyors”, sometimes simply as “valuers”.   Many large Real Estate companies such as CBRE call their appraisal department “Valuation” and speak of the “valuation of assets and property rights.”

Valuation Consultant/Analyst

This position goes under various names.  Typically it does not require an appraiser license.  More importantly, it requires more expertise in statistics, programming and database access than needed for typical appraiser positions.  Also, specific experience with automated tools such as Argus may be called for.  University degrees in real estate and finance are usually requested in job announcements but are accepted from a variety of other fields, especially technical/STEM areas.

Real Estate Broker/Agent

This is an individual licensed to work as a real estate broker.  His activities are regulated by state law, just as appraiser activities.  WIth respect to valuation:  

The Bureau of Real Estate regulates licensed California brokers and can discipline its members for professional violations.

In addition, California has enacted a comprehensive statutory scheme to ensure brokerage professionals comply with applicable laws and regulations.

• Licensed California appraisers, who render opinions of value pursuant to stringent professional standards, are subject to their own statutory regulation.
• In California, broker opinions of value are generally not considered “appraisals.”(5) Section 11302(b) of California’s Business and Professions Code defines the term “appraisal” to explicitly exempt opinions of value for real property made by licensed real estate brokers in connection with their brokerage activities. This section reads, in relevant part:
• ‘Appraisal’ means the act or process of developing an opinion of value for real property. The term ‘appraisal’ does not include an opinion given by a real estate licensee or engineer or land surveyor in the ordinary course of his or her business in connection with a function for which a license is required…and the opinion shall not be referred to as an appraisal.
• Therefore, licensed real estate brokers may provide opinions of value in connection with brokerage activities. These opinions would logically encompass suggestion of appropriate pricing for the listing, purchase, or lease of a property (i.e., a fundamental activity performed by brokers). Thus, these opinions are not “appraisals.” (However, a licensed California broker who describes the valuation as an “appraisal” in this context, where he or she does not have an appraiser’s license, may violate this provision).”

The Legality of Providing Broker Price Opinions of Value in California

Finally, lets propose a definition of “Valuation Engineer”:

Valuation Engineer

The term “Valuation Engineer”, in contrast, is meant to convey an individual who:

• • May or may not be a licensed broker or appraiser.

     

  • Is knowledgeable in 
    • Standard appraisal methodology,  
    • Broker pricing, 
    • Advanced statistical methods and tools such as
      • Multivariate Adaptive Regression Splines,
      • R-Language,
    • Database and spreadsheet technology,
    • Measurement of residential and commercial buildings according to the ANSI and BOMA standards, including the use of CAD software for creating exact floor plans and calculating floor areas of various types, 
    • Use of ArcGIS or similar technology for visualization of geographical and demographic data,
    • Someone who is adept at measuring business intangibles and solving measurement problems related to decision making.

Emphasis on Functional Utility

I would extend this definition a bit further and emphasize, that a valuation engineer is focused on precisely defining the value he is attempting to form an opinion of,  in respect to its functional utility – an emphasis that is the center of “value engineering” (a separate discipline), as well as the functional utility of all the components of the property or entity he is forming a value of.   

For example, if the valuation engineer is appraising a home for a Fannie Mae compliant loan, the functional utility of the value he provides is that the associated appraisal process and result complies to the specific requirements of Fannie Mae, the lending institution, state law and of course USPAP.    

One of the components of this valuation is the possible value of the bathrooms in the home and their functional utility.  Analyzing this latter component may lead the engineer to group 3/4 and full bathrooms as a single component, as they both serve the main purpose of providing a space for the occupant to take care of all personal hygiene issues before leaving for work or school in the morning or attending an event in the evening.  3/4 bathrooms include a shower, full bathrooms a shower and  bath.  Both include a toilet and sink.  Thus both serve more or less the same function.  

A 1/2 bathroom will include a toilet and sink and thus serves a specific purpose, although not allow a full body wash.  A 1/4 bathroom, as a single toilet without a sink, is basically useless by itself or of minimal value.  The same can be said of a room with only a sink.  Thus we should not simply add the various bathroom counts into a single total, as two 1/2 baths do not provide the same functionality as a 3/4 or full bathroom.  

Rather than some kind of Total Bathrooms count, we must have separate counts of complete bathrooms (3/4 or full), 1/2 and 1/4 baths.  We may in fact decide to disregard the 1/4 baths as insignificant.  This latter consideration is an example of domain expertise.  And thus, we might add here, anecdotally, that a valuation engineer is assumed to have domain expertise.  In other words, he not simply a data miner or statistics analyst.

The valuation engineer has sufficient knowledge, expertise and intelligence, that he should also be able to handle assignments that involve intangibles outside of the domain of real estate.

Summary

To summarize, Valuation Engineering includes:

• • Intermediate and advanced mathematics, in particular statistics.
  • Computer programming
  • Data mining techniques
  • Database technology
  • Traditional appraisal approaches to value including the Sales Comparison Approach, the Cost Approach and the Income Approach.
  • Douglas Hubbard’s techniques for measuring business intangibles
  • Measurement engineering and methodology
  • Value Engineering, insofar as its focus is on “functional utility” and insofar as one extends Valuation Engineering to cover “Prescriptive Analytics” – a subject to be discussed in a subsequent post.