Conditions, Limitations: Scope and Liability

Conditions and Restrictions: Scope of Application and Responsibility

Introduction

Conditions and restrictions are a cornerstone in determining the scope of the valuation and clarifying the appraiser’s responsibility. These elements are necessary to protect both the appraiser, the client, and any other parties that rely on the valuation results.

1. Definition of Conditions and Restrictions

Conditions and restrictions (assumptions❓ and Limiting Conditions) are statements and explanations that define the scope of the valuation and the assumptions upon which the results in the report are based.

• Assumption: Something considered true for the purposes of the valuation, but may not be true in reality. The assumption relies on available information or reasonable expectations and affects the value estimate.
• Limiting Condition: A statement or explanation that limits the application or assumptions of the conclusions in the report. It defines what can be inferred from the valuation and limits its scope.

2. Types of Conditions and Restrictions

Conditions and restrictions vary depending on the nature of the valuation, its purpose, and the circumstances surrounding the property. However, there are some common types that appear in most valuation reports:

1. Property Identity and Ownership Interest: These conditions and restrictions accurately define the property being valued and the type of real estate interest (absolute ownership, usufruct, lease, etc.).
2. Purpose of Valuation and Intended use❓: These conditions and restrictions clarify the specific purpose of the valuation (e.g., obtaining a loan, making an investment decision, settling a dispute) and the party that will use the valuation.
3. Valuation Effective Date: Indicates the date on which the estimated value reflects prevailing market conditions.
4. Assumptions Related to Ownership: The appraiser assumes that the property is marketable and free from hidden defects unless otherwise stated.
5. Inspection Limits: The valuation is not a land survey, engineering inspection, or environmental report. The valuation relies on visual inspection and available information and does not include a detailed inspection of all aspects of the property.
6. Uncertain Conditions: The valuation acknowledges that it relies on a limited amount of data and may be under uncertain conditions.
7. Reliance on External Information: The valuation relies on information provided by other parties (e.g., sales data, cost information). The appraiser assumes this information is accurate, but does not take responsibility for verifying it completely.
8. Assumptions regarding completion of work: If the property is under construction or needs repairs, the valuation assumes that the work will be completed in a professional manner and according to specifications.

3. Importance of Conditions and Restrictions

Conditions and restrictions play a vital role in the valuation process, achieving three main objectives:

1. Clarifying the meaning of the valuation: Conditions and restrictions help the client and other readers of the valuation report understand its meaning and interpret the results correctly.
2. Consumer protection: Clarifying the terms and conditions is more important as federal law requirements increase to provide borrowers with copies of the valuation reports.
3. Defining the appraiser’s responsibility: The conditions and restrictions define the circumstances under which the appraiser can be held liable for the results of any actions taken based on the valuation report.

4. Practical Applications and Examples

• Example 1: John applies for a loan from ABC Bank to buy a house. ABC Bank gave John a copy of the valuation report that was prepared regarding John’s loan application. By clearly stating (in the limiting conditions) that the valuation does not constitute a survey or legal opinion of the status of title, the valuation report can prevent John from assuming that the property boundaries and ownership are in order.
• Example 2: The valuation report includes a condition that the estimated value is based on the assumption that the property will be used as a hotel. If the buyer converts the property into residential apartments, the estimated value will not be correct, and the appraiser will not be responsible for any losses the buyer may incur.
• Example 3: The valuation clarifies that the inspection was based on information from a third party about the costs of the restoration. If the actual costs are much higher, the appraiser is not responsible, as long as he clarified in the valuation his reliance on external information.

5. Impact of Conditions and Restrictions on the Valuation Process

Conditions and restrictions affect all stages of the valuation process, from defining the scope of work to analyzing data and presenting results.

• Defining the scope of work: Conditions and restrictions help define the scope of work required to conduct the valuation.
• Data analysis: Conditions and restrictions affect how data used in the valuation is analyzed.
• Presenting the results: The conditions and restrictions define how the results should be presented in the valuation report.

6. Conditions and Restrictions in Standard Valuation Models (Example: Fannie Mae and Freddie Mac)

Fannie Mae and Freddie Mac have made significant changes to the statement of assumptions, limiting conditions, and appraiser certification, both in terms of language, meaning, and content. The old Form 439 was withdrawn, and the expanded wording of the new document became part of the six pages of the 2005 Uniform Residential Valuation Report.

Key points in the new model:

• Scope of Work: The model defines the minimum acceptable scope of work requirements that are considered satisfactory to Fannie Mae. The appraiser is permitted to expand the scope of work for a complex valuation.
• Intended Use: This model can only be used for a mortgage financing transaction.
• Intended User: The lender/client as stated in the report. According to USPAP, all intended users must be named by name or type.
• Market Value Definition: The same as stated elsewhere in the text.
• Statement of Assumptions and Limiting Conditions:
  • Paragraph 1. States that legal ownership is not a concern of the appraiser. The appraiser assumes the property is marketable.
  • Paragraph 2. Indicates that the illustration provided in the report is approximate only. It is not a survey.
  • Paragraph 3. While the appraiser may have looked at FEMA flood maps, there is no guarantee on the part of the appraiser regarding the accuracy of the maps. Again, the appraiser is not a surveyor.
  • Paragraph 4. The appraiser will not testify or go to court unless prior arrangements are made to do so.
  • Paragraph 5. While the appraiser may have noted the apparent adverse conditions discovered during his research and inspection, unless otherwise stated, the appraiser has no knowledge of any hidden and unapparent adverse conditions and assumes there are none. The appraiser is not a building inspector, engineer, or environmental scientist.
  • Paragraph 6. The appraiser assumes that work in progress or subject to completion will be done in a professional manner (the old form used the term “workmanlike manner”).
• Appraiser Certification: The new document consists of twenty-five paragraphs❓ instead of the nine in the old document. Current USPAP certifications appear to be contained in the new document, but the wording differs from that contained in the USPAP document. Fannie Mae appears to have unilaterally added new elements to the appraiser certification simply because it feels it can. Many of these new certifications were developed to make appraisers aware of some of Fannie Mae’s unacceptable lending and valuation practices. In addition, there are many title valuation efficiency issues.

7. Professional Responsibility

Appraisers have a professional responsibility to their clients and other parties who rely on their reports. This means that they must exercise due diligence, skill, and competence in conducting the valuation.

• Concept of Due Diligence: The appraiser must make a reasonable effort to collect and analyze relevant data, use appropriate valuation methods, and present the results clearly and accurately.
• Defining Responsibility: The conditions and restrictions define the scope of the appraiser’s responsibility. If the appraiser does not comply with the conditions and restrictions, he may be liable for any losses incurred by other parties due to the valuation.
• Professional Liability Insurance: Appraisers should obtain professional liability insurance to protect themselves from potential lawsuits.

8. Conclusion

Conditions and restrictions are an integral part of the real estate valuation process. They define the scope of the valuation, clarify the assumptions upon which the results are based, and define the appraiser’s responsibility.

9. Related Mathematical Formulas (Where Applicable)

In some cases, conditions and restrictions may include mathematical formulas or equations to clarify the assumptions used in the valuation. For example:

• Discount Rate:

  • r = r_f + r_p + r_i

    • Where:
      • r is the discount rate.
      • r_f is the risk-free rate of return.
      • r_p is the property-specific risk premium.
      • r_i is the expected inflation premium.
    • Capitalization Rate:

  • Cap Rate = NOI / Value

    • Where:
      • NOI = Net Operating Income
      • Value = Estimated Value