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Mass Appraisal: An Introduction to Multiple Regression

Analysis for Real Estate Valuation

Article  in  Journal of Real Estate Practice and Education · January 2004

DOI: 10.1080/10835547.2004.12091602

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Randall S. Guttery C. F. Sirmans

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Mass Appraisal: An Introduction to
Multiple Regression Analysis for Real
Estate Valuation
John D. Benjamin,* Randall S. Guttery** and C. F. Sirmans***

Focus
This case study presents an introduction to the basics of real estate appraisal and
multiple regression analysis; in particular, as used in real estate valuation for mass
property tax assessment. While real estate researchers, appraisers and some tax
assessors have used multiple regression analysis for many years, its use by a large
number of assessors is relatively new. The purpose of this case is to expose students
to standard appraisal approaches including the market comparison technique as well
as the advantages and disadvantages of using multiple regression analysis. In their
answers to the case, students are encouraged to explore and develop solutions, so as
to understand how to use the market comparison approach and multiple regression
analysis for real estate valuation.

Setting
The real estate tax assessment process is used to provide an introduction to multiple
regression analysis. The tax assessor’s office in a small west Texas county has always
assessed properties through manual market comparison analysis. This manual process
uses recently sold properties that are in close proximity to the subject property to
make corresponding weighted adjustments. After going to a seminar on multiple
regression analysis for mass appraisals, the county tax assessor employs a university
professor to explain how multiple regression analysis works for real estate valuation
and mass assessment, as well as what its relative benefits are over the existing manual
system. He invites his staff, the county commissioners, and others to a one-night
seminar that explains multiple regression analysis. This seminar presented by a
university professor to Texas participants is used educate case readers about real estate
appraisal and multiple regression analysis.

Exhibits
Multiple regression handout presented in Appendix.

Availability
This case is available through the ARES clearing house.

*American University, Washington, D.C. 20016 or jbenj@american.edu.

**University of North Texas, Denton, TX 76203 or guttery@unt.edu.
***University of Connecticut, Storrs, CT 06269 of cf@sba.uconn.edu.

65
66 Journal of Real Estate Practice and Education

Teaching Notes
Teaching Notes are available and emphasize the objectives that the students are
expected to master. Generalized solutions for the case are included.

Introduction
This case study presents an overview of the basics of multiple regression analysis and
illustrates its use in real estate valuation for mass property tax assessment. While real
estate researchers, appraisers and some tax assessors have used this methodology for
many years, its use by a large number of assessors is relatively new. Lusht (2001)
suggests that multiple regression analysis ‘‘. . . can be used to value a large number
of properties quickly and economically, which helps explain its (growing) popularity
with tax assessors.’’ The Appraisal of Real Estate (2001), published by The Appraisal
Institute, offers an in-depth analysis of this methodology. Smith, Root, and Belloit
(1995), Downing and Clark (1997), Allison (1998), Baldwin (1999), Betts and Ely
(2001) and Ratterman (2001) investigate the worthiness of multiple regression analysis
and its application to real estate valuation.

Background: Back to Texas with New Information

Mr. Austin Modano has recently returned from a business trip to the annual tax
assessors’ conference in Washington, D.C. Being the assessor of a small west Texas
county, he is a bit in awe of the advances in software technology and statistical
techniques being used by his counterparts around the country. In particular, he is
intrigued by the use of multiple regression analysis to estimate real estate value for
taxation purposes. His county has always assessed properties the old-fashioned
way—through manual market comparison analysis of recently sold properties that are
in close proximity to the subject property, a costly and time-consuming process.
Furthermore, it requires hiring additional appraisers during the reassessment process
and it is prone to human bias and error.

Changing from his county’s assessment methodology to one using a multiple

regression analysis for estimating value now seems preferable for several reasons.
First, he realizes that in multiple regression analysis, data from all sales are utilized,
rather than data from only three or four comparable properties that have sold recently.
Appraiser bias with respect to choosing comparables or ‘‘comps,’’ therefore, would
be eliminated. Second, rather than ‘‘guesstimating’’ adjustments in magnitude and
direction, the multiple regression software output statistically estimates the
adjustments through the values and signs of the regression coefficients. In other words,
having to calculate the magnitude (i.e., the dollar value) of each characteristic, such
as a fireplace or a swimming pool’s contributory value, would not be necessary.
Unnecessary as well would be determining whether or not a characteristic is a positive
or a negative attribute. In multiple regression analysis, the direction of the adjustment
is determined simply by the sign of the coefficient from the regression equation’s
output. Last, matched pairs analysis—an appraisal technique used in the traditional
market comparison approach—becomes unnecessary. Although switching to a

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 67

statistical analysis methodology would be costly and may require staff training, the
ease of mass appraisals for property tax assessments would largely overcome these
costs in the long run. Local elected officials, however, would also have to be persuaded
of the benefits for these changes.

Believing that his county is ripe for statistical modernization, Austin decides to hold
a seminar for his staff and the relevant county officials. His mission is to educate
them on the benefits of utilizing multiple regression analysis. Not feeling qualified to
teach the seminar personally, he calls on a local real estate professor and friend, Dr.
Katherine ‘‘Kat’’ Charbonneau, who teaches at a nearby university and has expertise
in real estate valuation. Having attended Kat’s community outreach classes in real
estate, Austin is confident that she is the right person to get his associates up to speed
on the use of multiple regression analysis.

Austin and Kat meet at her very small, nondescript university office. She explains
that to teach the class effectively to novice students, she would need to present an
overview of the appraisal process in general and the market comparison approach
(MCA) as a specific method to appraising real estate. This overview would include
the advantages and disadvantages of the MCA technique, as well as a demonstration
of how its shortcomings could be overcome by using multiple regression analysis.
Then she would define what regression analysis is, how it works and why it is a
superior tool for assessing thousands of properties annually. Austin agrees with Kat’s
outline and suggests that she present a seminar. She agrees to do so in a couple of
weeks, once final exams are graded and her semester at the university is completed.

Meeting with Seminar on the Appraisal Process

On a Wednesday night following the completion of her university semester, Kat meets
with Austin’s staff, several county commissioners, the Citizens for Financial Integrity
Committee, and some interested appraisers and Realtors for the seminar. In order to
provide the background necessary for appreciating the need for statistical valuation
techniques, Kat presents an overview of the basics of real estate appraisal. She begins
her presentation by explaining the appraisal process.

The first step in the appraisal process is to define the problem by identifying the
property to be appraised, the property rights and the valuation date. One must also
define the use and scope of the appraisal, as well as stating the appraisal’s limiting
conditions. In this case, the appraisals are to be used for real estate tax assessment
purposes.

The second step includes the preliminary analysis, data selection and data collection,
both general and specific. General data is information related to environmental, social,
economic and governmental trends in the local market area. These include, but are
not limited to, land use constraints, demographic changes, supply/demand factors and
zoning changes. Specific data include such things as property location and
improvements. Data for these various attributes allow comparison of the subject
property to the other recent property sales.
68 Journal of Real Estate Practice and Education

The third step in the appraisal process is highest and best use analysis. This appraisal
principle requires the appraiser to consider the subject property as though its use
generates the highest net return to the property over the holding period, given current
market conditions. To determine highest and best use, the use must be legally
permissible (e.g., adhere to zoning laws), physically probable (e.g., the size of the
property must satisfy the use), financially feasible (i.e., benefits must exceed the costs)
and maximally productive (i.e., the use chosen must satisfy the aforementioned three
requirement and maximize expected returns).

Land value estimation, the fourth step, assumes that the land is vacant and that the
land is improved (ready to be built upon). Four methods available to the appraiser for
land value estimation are: (1) the sales comparison method; (2) the value extraction
method; (3) the land residual method; and (4) the ground rent capitalization method.
Kat explains that she will not discuss the land valuation methods further, given that
they are primarily used for commercial real estate appraisals; instead, she will discuss
the valuation of residential properties.

The fifth step is application of the three appraisal approaches: market comparison,
income capitalization and cost. The market comparison approach suggests that the
indicated value of the subject property equals the value-weighted cash sales prices of
similar properties that have sold recently and are in close proximity to the subject
property, plus/minus adjustments for dissimilar characteristics. The income
capitalization approach states that the indicated value of the subject property equals
the present value of the expected future income stream generated from any income
producing real estate investment. The cost approach implies that the indicated value
of the subject property equals the value of the land as though it was vacant, plus the
depreciated value of the improvements permanently attached to the land. These three
valuation approaches are mostly important for commercial properties, and Kat
reiterates that she wants to focus on the residential valuation problem.

The sixth and final step in the appraisal process is to reconcile the values of each
approach and to determine a final value estimate. In each appraisal approach, the
indicated value is value-weighted. Respective weights for each are then multiplied by
their indicated values and summed to determine a final value estimate. For example,
if an owner-occupied residential dwelling were appraised for $150,000 using the
market comparison approach and $155,000 using the cost approach, the appraiser may
place a 70% weight on the market comparison approach value from subjective
experience on the job, but only a 30% weight on the cost value,1 for a final value
estimate of $151,500 [($150,000 * 70%) ⫹ ($155,000 * 30%)].2 In the past, the county
has been using a similar assessor-assigned weighted methodology to determine
residential valuation and, thus, the tax assessment value for each property. The
seminar’s participants realize that a statistical approach might offer an unbiased
improvement over the existing subjective weighting method. A computer-based
approach would also offer the potential for much quicker and less costly results.

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 69

Kat’s Presentation of the Market Comparison Approach

Kat then narrows her discussion by detailing the market comparison approach (MCA)
for single-family residential properties. She reminds those attending the meeting that
the indicated value of any subject property equals the value-weighted cash sales prices
of similar properties that have sold recently and are in close proximity to the subject
property, plus/minus adjustments for dissimilar characteristics. She then explains that
this approach is based in large part on the Principle of Substitution, which posits that
‘‘. . . the value of a property tends to be set by the price that would be paid to acquire
a substitute property of similar utility and desirability within a reasonable period of
time. Therefore, the reliability of the MCA is diminished if substitute properties are
not available in the market.’’3

Kat proceeds with a discussion of the various steps of the MCA. The first step is to
gather comparable sales data. This includes sales data for all comparable properties
(also known as ‘‘comps’’) that have sold recently and are in close proximity to the
subject property. These data could be compiled from public records, the Multiple
Listing Service (MLS) database, lenders, builders, contractors and possibly appraisers.
Many attendees at the meeting nod in agreement with Kat’s comments. She continues
saying that data would need to be ‘‘cleaned’’ for inaccuracies in the description of
the property’s attributes. This would be labor intensive at first.

The second step is to choose the comps from Step 1 that are most similar to the
subject property. Some statisticians argue that this step minimizes the credibility of
the MCA because the appraiser discards otherwise valuable data from omitted
comparable properties and reduces the sample size to as little as three observations.
In appraising an owner-occupied residential dwelling, the appraiser most typically is
required to retain only three or four recent sales (i.e., within six to nine months) that
are in close proximity to the subject property (i.e., within a three- to five-mile radius,
if possible). But what if Step 1 produced 75 legitimate comps? Step 2 eliminates
information that otherwise could have been provided by the other 72 sales. Moreover,
one likely will not convince a statistician that a sample size of three is statistically
significant, so inferences are weak at best and useless at worst. Certainly, the county
with its recent growth has sufficient sales comparables to merit a statistical analysis.

Step 3 requires the appraiser to adjust the comps’ sale prices for dissimilar
characteristics, relative to the subject property. The five most common adjustments
are:
1. Physical Characteristics: Valuation differences based on dissimilar
physical characteristics, such as square feet of living area, the number of
bedrooms and bathrooms, lot size, overall quality, age, the number of
days the property was exposed to the market and other factors such as
property condition.
2. Location: Valuation differences based solely on the desirability of
different locations.
3. Market Conditions: Changes in the overall economy that may affect
value.
70 Journal of Real Estate Practice and Education

4. Financing Concessions: Special below-market seller or third-party

financing.
5. Conditions of Sale: Special sales concessions offered by the seller, such
as seller-paid closing costs or discount points, non-arms-length deals,
divorce or lawsuit settlements, condemnation sales, tax sales and
foreclosure sales.
The appraiser then must quantify any adjustments by both magnitude and direction.
The magnitude of the adjustment represents how much a characteristic contributes to
overall value. For example, an in-ground swimming pool may cost $35,000 to install,
but if it contributes only $10,000 to overall value, then there would be only a $10,000
adjustment to the comparable’s sales price.

The direction of the adjustment represents whether a comparable’s sales price should
be adjusted downward or upward by the dollar magnitude. If the comp has the
preferred characteristic over the subject property, then make a downward adjustment;
if the subject has the preferred characteristic over the comparable property, then make
an upward adjustment. The theory underlying this strategy is to transform the
comparable property to be like the subject property. For example, if the comparable
property has the aforementioned pool but the subject property has no pool, then by
theoretically removing the pool, appraisal theory suggests that the comp would have
sold for $10,000 less. If, on the other hand, the subject has a $2000 patio while the
comp has no patio, then theoretically transforming the comp so that it also has a patio
would result in the comp having sold for $2000 more.

Step 4 of the MCA is to determine the adjusted market price (AMP) for each
comparable property. The AMP is simply a comp’s sales price, plus/minus all
adjustments for dissimilar characteristics that are quantified in Step 3. Theoretically,
the AMP represents the transformed value of the comp, as though it were now the
subject property. Step 5 is to value weight the comps’ AMPs. The comparable property
that is considered to be the most similar to the subject property receives the highest
weight and vice versa. These subjective weights are a function of the number of
adjustments for dissimilar characteristics and the magnitude of each adjustment (i.e.,
the greater the similarity, the greater the weighting expressed in percentage terms).
The sixth and final step is to determine the subject’s indicated value, which is
calculated by summing all the weighted AMPs from Step 5.

Kat now explains to the group that the market comparison approach based on sale
prices has several limitations. The past does not necessarily represent the future, but
the MCA analysis is based on past trends (i.e., historical data of recent sales), rather
than current data or forecasts. In addition, it relies on sales data that may not exist in
sufficient quantities, particularly in less populated areas. Furthermore, even if there
are several recent sales, these properties may be so dissimilar to the subject property
that the MCA is rendered useless. One or two of the meeting attendees nod because
they know part of this west Texas county is still rural with limited residential sales.

Another drawback is that the appraisal becomes obsolete fairly quickly. Suppose an
owner-occupied residential dwelling were to be appraised. If ‘‘sold recently’’ is defined

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 71

as no more than six to nine months, then in the best case scenario, all comparable
properties used for the MCA analysis would be outdated within only two to three
quarters. A short time window exists for selecting comparables in order to make an
appraisal.

Most importantly, the value-weighting process used in the MCA, as applied to the
adjusted market prices, can be very subjective. Who is to say that Comp #1 should
receive a 40% weight, rather than a 25% weight? Multiple regression analysis,
therefore, may likely overcome these deficiencies, particularly for tax assessors who
must assess thousands of properties annually.

Multiple regression analysis improves over the MCA approach by using many recent
sales versus just a few. All sales are adjusted for statistically significant factors such
as living area. This statistical analysis decreases the likelihood of human error and
the problems of small samples.

At this point Kat encourages the group to take a coffee break prior to her beginning
her presentation of her numerical illustration of multiple regression analysis.

The Nuts and Bolts of Multiple Regression Analysis: An Example

After the break, Kat begins her explanation of multiple regression analysis. She sets
the scene for the assembled group by telling them their task as a tax assessor is to
estimate the value of the subject property using the regression analysis output
provided. You determine that the significant explanatory variables include square feet
of living area, the number of days the property was on the market, square feet of
garage area, whether there exists a fireplace and the age of the property. The subject
property has 1990 square feet of living area, was on the market for 76 days, has a
450 square foot garage and a fireplace, and is 8 years old.

The regression equation to be estimated is:

SPi ⫽ ␤0 ⫹ ␤1LAi ⫹ ␤2DOMi ⫹ ␤3GARAGEi ⫹ ␤4FPi ⫹ ␤5AGEi ⫹ ui, (1)

where SP is the response variable for the ith observation, ␤0, ␤1, ... , ␤5 are the
parameters that are estimated, and LA, DOM, GARAGE, FP and AGE (all important
property characteristics) are the independent or regressor variables. The error term, u,
is the unknown error which represents the impact of all possible factors other than
the explanatory variables on the response variable, SALES PRICE (SP). SALES PRICE
is the variable that you as an assessor are trying to accurately estimate.

Using data supplied by Austin, Kat passes out a handout on the multiple regression
computer results (She also distributes an additional handout with more specific
information regarding the mechanics of multiple regression analysis and this handout
is contained in the Appendix).
72 Journal of Real Estate Practice and Education

Constant 235.32
Standard error 115.22
R2 0.742
No. of observations 185

Variable Coefficient Std. Error t-Statistic

Sq. Ft. of Living Area (LA) 64.46 24.02 2.68

Days on Market (DOM) ⫺8.19 2.20 ⫺3.72
Sq. Ft. of Garage Area (GARAGE) 16.10 5.28 3.05
Fireplace (FP) 1245.12 1599.66 0.77
Age of Structure (AGE) ⫺2555.02 742.11 ⫺3.44

The 185 observations are from recent residential sales within three miles of the subject
property. The comparables have sales prices within plus or minus $25,000 of the
subject property. The t-Statistic for each explanatory variable (i.e., the coefficient
divided by the standard error) is reported in the table above. All t-Statistics are greater
than 兩2.57兩, other than for FP, suggesting these regressors are significant at the 1%
level in explaining SP. FP is insignificant, so it adds no statistically significant
explanatory power to SP. The R-squared statistic, also known as the coefficient of
determination, measures the correlation between the dependent and independent
variables. An R-squared statistic of .742 suggests that approximately 75% of the total
variation in sales price is explained by the five independent variables (LA, DOM,
GARAGE, FP and AGE). In other words, these are the variables upon which the
comparison of value hinges. In academic terms, it is known as the linear influence of
the independent right-hand-side variables. One of the attendees laughs at Kat’s
academic jargon. She smiles and continues.

The point is that the influence on sales price of each explanatory variable, both in
direction and magnitude, has been estimated by the model and, thus, not subject to
human error. Every additional square foot of living area (LA) results in a $64.46
increase in sales price. As expected, LA is positive because more LA is perceived as
a positive effect on SP, all else held equal. Second, each additional day a property is
on the market (DOM) results in an $8.19 decrease in sales price. DOM is negative
because the longer a property is on the market, the greater the probability that the
property is undesirable at its asking price. With respect to the size of the garage, every
additional square foot of garage area results in a $16.10 increase in sales price.
GARAGE is positive because more garage area is perceived as a positive effect on
SP. If the property has a fireplace (FP), then the sales price would increase by
$1245.12 because it is perceived to add value. From a statistical perspective, however,
the variable insignificantly affects value, so the researcher may choose to rerun the
regression equation with FP omitted. Finally, each additional year of age will cause
a $2555.02 decrease in sales price because older houses are less desirable than new
ones. This decrease is due to physical depreciation, functional obsolescence and
external depreciation.

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 73

From the regression results above, the estimated assessed value of the subject property
would equal $115,938. This value is calculated by multiplying each coefficient
estimated from the equation with the subject property’s respective characteristic,
summing these products and adding the intercept term, ␤0, which was estimated to be
$235.32. That is:

Assessed Value ⫽ $235.32 ⫹ ($64.46 ⫻ 1990 LA) ⫺ ($8.19 ⫻ 76 DOM)

⫹ ($16.10 ⫻ 450 GARAGE) ⫹ ($1245.12 ⫻ 1 FP)
⫺ ($2555.02 ⫻ 8 years) ⫽ $115,938

Summary and Thoughts for Further Discussion

The group applauds Kat’s suggested solution to their mass appraisal needs. Kat again
says that, through its coefficient estimates, the multiple regression analysis makes
possible factor weightings using a large number of comparable sales so that any one
property can be assigned accurate assessment value.

Several participants raise questions. One wants to know if this methodology really
costs less in the long run, given the need to update data from recent sales and to
install the multiple regression software with appropriate personnel training. Kat
responds that there are benefits such as lower long-term costs, less human bias and
error when making adjustments for property differences, and more easily updated
assessment figures. Austin also notes that the county is occurring significant expenses
now when updating data for the old manual weighting system. He comments that a
case-by-case system of human weighting will be replaced by a multiple regression
equation that would update itself over time. Adding recent sales data would allow the
equation to update itself within seconds by way of the multiple regression software
program.

Another participant questions the political ramifications of implementing this new

system. What is the additional cost to the county and would the voters accept this
new technology? Kat comments that few people know about how assessments are
actually performed—unlike the visible problems associated with ‘‘hanging chads’’ in
public elections. This outlay for the updated assessment technology would be viewed
as a beneficial investment that could easily be covered in the existing assessment
office budget. Austin agrees.

One county commissioner inquires if after the new multiple regression analysis
software is up and running could the county actually reduce the number of employees
in the assessment office. Austin replies humorously that after the system is
implemented then the personnel needs for the office could be ‘‘re-assessed.’’

Questions
1. Should the assessor’s office continue to value single-family residential
properties using the manual method or should multiple regression
74 Journal of Real Estate Practice and Education

analysis be utilized? What are the benefits and costs of changing

methodologies?
2. Kat describes the first step of the MCA. How do ‘‘sold recently’’ and
‘‘in close proximity’’ differ by property type? Give specific examples.
3. The MCA’s third step is to quantify the magnitude of the adjustment.
Explain at least two ways that appraisers estimate this magnitude.
4. Highland Shores National Bank has employed you to review an appraisal
that was performed on a house in the Woodlawn subdivision. Sales for
the previous nine months in the area and the appropriate characteristics
are given in the table below. Using multiple regression analysis, evaluate
the previous appraisal of $174,600. Use your regression output to defend
and explain your reasoning. Is the appraisal supported by your
regression? Explain.

Square
Sales Price Square Feet of Feet of Net Month House Age of House Fireplace
Comp ($) Living Area Area Sold in Years (Y / N)

1 146,250 2,202 698 10 3 Y

2 137,675 2,343 1,058 07 10 Y
3 170,950 2,332 1,269 12 4 Y
4 147,375 2,478 960 09 12 Y
5 156,750 2,336 1,056 12 10 Y
6 153,000 2,336 1,056 12 10 Y
7 141,200 2,371 914 04 11 Y
8 142,550 2,137 860 11 4 N
9 136,625 2,375 903 08 11 Y
10 148,700 2,354 1,032 06 9 Y
11 140,500 2,260 979 07 8 Y
12 152,975 2,274 1,057 12 10 N
13 143,200 2,206 765 11 2 Y
14 154,675 2,394 1,220 04 9 Y
15 153,300 2,260 883 06 2 Y
16 162,875 2,747 928 03 10 Y
17 150,925 2,601 1,082 08 14 N
18 159,475 2,580 1,270 10 9 Y
19 161,325 2,388 803 05 2 Y
20 165,750 2,440 1,064 03 6 Y
21 150,650 2,430 1,178 08 8 Y
22 146,175 2,547 1,101 04 15 Y
23 140,325 2,563 1,032 03 12 Y
24 143,550 2,612 921 03 13 Y
25 180,450 2,545 991 12 5 Y
26 160,450 2,671 1,309 05 13 Y
Subject of ? 2,450 1,125 12 8 Y
Appraisal

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 75

Appendix
Multiple Regression Analysis
Below is a detailed discussion multiple regression analysis (MRA). While most
academicians (and some students) are well-versed on this topic, it is included as a
review for those who have not used MRA recently and is provided by Kat to the
participants in the meeting. Recognizing that Austin’s group knows very little about
the subject, she begins her discussion of MRA with a basic overview. She explains
that it is a way to show how a response variable such as Y will vary with a set of
independent (sometimes know as explanatory) variables such as X1, X2, . . . , Xn.

Kat’s Handout: An Overview of Multiple Regression Analysis

When we estimate the regression equation through a computer statistical package or
program, we are modeling our response variable Y as a function of the independent
variables or Xs. The variable Y will be determined by two components: a systematic
component captured by the multiple regression equation and a random component
that is unknown. The second or random component is the part of the model that does
not explain or capture variable Y’s response. The random component is usually
represented by the error term, u.

Suppose that a response variable Y can be predicted by a linear combination (or

equation) of some independent variables X1, X2, . . . , Xn. Using MRA contained in
statistical or spreadsheet software, tax assessors or real estate appraisers can estimate
the coefficients or ␤ parameters in the equation. These coefficients or ␤ parameters
quantify how much a particular characteristic (independent variable or X) influences
the property’s sales price. Thus, a multiple regression equation for two X’s (two
independent or explanatory variables) can be described as:

Yi ⫽ ␤0 ⫹ ␤1X1i ⫹ ␤2X2i ⫹ ui, (1a)

where Yi represents the ith value of the dependent variable, and X1i represents the ith
observation of the first X independent variable or X1, and X2i represents the ith
observation of the second X independent variable or X2. Two subscripts are used for
each variable: the first subscript represents the variable number and the second one
represents the observation number. This equation is a linear model.

The method of ordinary least squares or OLS is used to estimate the ␤0, ␤1 and ␤2
parameters of the equation. This method is a statistical technique that finds the best
linear unbiased estimates (BLUE) under classical statistical assumptions. This process
estimates ␤0, ␤1 and ␤2 by minimizing the sum of squares of the errors between the
values of Y predicted by the equation and the actual values of Y.4 The actual or true
values of ␤0, ␤1 and ␤2 are unknown, but the multiple regression model will try to
estimate them. The value ␤0 is a constant term in the model. The random part of the
equation is captured by ui, and it represents the impact of all other factors besides the
independent variables (i.e., omitted explanatory variables) on the response variable Y.
76 Journal of Real Estate Practice and Education

Regression analysis might be used to find out how well a house’s selling price or
value (for tax assessment, appraisal, or other reasons) can be predicted if several
variables that help explain sales price (such as the square footage of the house and
the number of bathrooms) are known.5 The process begins by collecting recent sales
prices for homes in a particular neighborhood or census tract as well as their square
footage, the number of bathrooms, age, and so forth. The intercept ␤0 can be estimated
and the variables ␤1, ␤2, ... ␤n of a sales price equation can be used:

SALES PRICEi ⫽ ␤0 ⫹ ␤1SQUARE FOOTAGEi ⫹ ␤2BATHROOMSi ⫹ ... ⫹ ui, (2a)

where SALES PRICE is the response variable; ␤0, ␤1, ... , ␤n are the parameters that
are estimated; and SQUARE FOOTAGE (X1i), BATHROOMS (X2i), etc. are the
independent or regressor variables. The error term or u is the unknown error which
represents the impact of all possible factors other than the explanatory variables on
the SALES PRICE.

Then a multiple regression analysis is used to test hypotheses about the relationship
between a dependent variable, Y, and two or more independent variables, Xs. Multiple
regression can also be used to make predictions about the Y variable. That is why the
statistical technique is useful to determine a property’s likely sales price or worth.

For the case of independent or explanatory variables, the model can be written as:

Y1 ⫽ ␤0⫹ ␤1X1i ⫹ ␤2X2i ⫹ n . . . ⫹ ␤n Xni ⫹ ui, (3a)

where Xni, represents the ith observation on the independent variable Xn.

Several assumptions are made when performing MRA. First, all relevant independent
variables are included, and the functional form of the model is correct. Typically, the
functional form of the model is linear. Second, the expected value of each error term,
u, is zero (that is, they sum to zero, with negative error terms being offset by positive
error terms) and it represents the impacts of all possible factors other than the
explanatory variables. Third, the variance of the error terms is constant, and they are
uncorrelated (that is, if they were correlated or connected, then it may indicate that
an important independent variable is missing). Finally, an assumption is made that the
error terms are normally distributed (meaning that they are random and would fit a
normal distribution curve).

Another assumption required for the multiple regression linear model is that there is
no exact linear relationship between the X’s (the independent or explanatory variables).
If two or more explanatory variables are perfectly linearly correlated, it will be
impossible to calculate parameters of the equation. If two or more explanatory
variables are highly but not perfectly linearly correlated (e.g., including both bedrooms
and bathrooms), then the parameter estimates can be calculated, but the effect of each
of the highly linearly correlated variables on the explanatory variable cannot be
isolated. Thus, the less connected the variables are, the more representative the model.

VOLUME 7, NUMBER 1, 2004

Mass Appraisal 77

The error term (also known as the disturbance or stochastic term) measures the
deviation of each observed Y value from the true (but unobserved) estimated value or
regression line. The error terms arise because: (1) numerous explanatory variables
with only slight, and irregular effects on Y are omitted from the exact linear
relationship; (2) there are possible errors of measurement in Y; and (3) random human
behavior is present.6

Endnotes
1. If fewer sales were available, an appraiser may place less weight on the MCA because
reliability is diminished.
2. Because this is not an income producing property, the income capitalization approach is not
indicated.
3. The Appraisal of Real Estate, 12th edition, 2001.
4. Graphically, these error terms are quantified as the vertical distance between a plotted
observation and the true regression line.
5. Researchers have determined that several variables help explain a house’s sales price. They
include, but are not limited to, square feet of living area, square feet of net area under roof,
the number of bedrooms, the number of bathrooms, the age of the property, the lot size, the
location, a time trend variable to proxy economic conditions and a swimming pool.
6. For more information on multiple regression analysis, see Smith, Root and Belloit (1995),
Downing and Clark (1997), Allison (1998), Appraising Residential Properties (1999),
Baldwin (1999), Betts and Ely (2001), Lusht (2001), Ratterman (2001) and The Appraisal
of Real Estate (2001).

Suggested Readings
Allison, P. D., Multiple Regression: A Primer, The Pine Forge Press Series in Research Methods
and Statistics, 1998.
Appraising Residential Properties, 3rd Edition, The Appraisal Institute, 1999.
Baldwin, P. N., Statistics: Know-How Made Easy, LmIT Publishing Co., 1999.
Betts, R. M. and S. J. Ely, Basic Real Estate Appraisal, 5th Edition, Prentice-Hall, 2001.
Downing, D. and J. Clark, Statistics: The Easy Way, Barron’s Educational Services, Inc., 1997.
Lusht, K. M., Real Estate Valuation, KLM Publishing, 2001.
Ratterman, M., Residential Sales Comparison Approach: Deriving, Documenting, and
Defending Your Value Opinion, The Appraisal Institute, 2001.
Smith, H. C., L. C. Root and J. D. Belloit, Real Estate Appraisal, 3rd Edition, Gorsuch
Scarisbrick Publishers, 1995.
The Appraisal of Real Estate, 12th Edition, The Appraisal Institute, 2001.

The authors acknowledge the helpful comments and suggestions of Bill Hardin and an
anonymous reviewer.
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