Appraisal Foundations: Defining the Assignment - Assumptions, Scope, and Intended Use

Chapter 3: Appraisal Foundations: Defining the Assignment - Assumptions, Scope, and Intended Use

A. INTRODUCTION

Defining the appraisal assignment is a crucial first step in the appraisal process. A poorly defined assignment can lead to inaccurate value conclusions, misinformed decisions by the client, and potential liability for the appraiser. This chapter delves into the key elements involved in defining the assignment, namely, the intended use, the scope of work, and the assumptions and limiting conditions. A clear understanding of these elements is essential for producing a credible and reliable appraisal report.

B. DETERMINING THE INTENDED USE

The intended use of the appraisal significantly influences the entire appraisal process, from data collection to analysis and reporting. The intended use defines why the appraisal is being performed and how the client will utilize the value opinion.

1. Impact on Valuation Approach

Different intended uses may necessitate emphasizing different valuation approaches. The three primary approaches to value are:

• Sales Comparison Approach: This approach relies on analyzing sales data of similar properties (comparables) to derive a value indication for the subject property. It is most applicable when a robust market for comparable properties exists.
• Cost Approach: This approach estimates the cost to reproduce or replace the subject property, less any accrued depreciation. It is particularly useful for valuing unique or specialized properties where comparable sales data is limited.

• income capitalization approach❓❓: This approach converts the anticipated future income stream of the property into a present value estimate. It is primarily used for income-producing properties such as apartments, office buildings, and retail centers.

  Example: If the intended use is for mortgage lending, the lender is primarily concerned with the resale value of the property. Consequently, the appraiser might place greater emphasis on the sales comparison approach. If the intended use is for investment decision-making, the income capitalization approach may be given more weight.

2. Minimizing Liability through Clearly Defined Intended Use

The appraiser should explicitly state the intended use of the appraisal in the report. This limits the validity of the value opinion to that specific purpose and protects the appraiser from liability if the appraisal is used for an unintended purpose.
Example: An appraisal performed for property tax assessment purposes should not be relied upon by a prospective buyer when making a purchase decision. The appraiser’s liability is limited to the tax assessment context.

The liability can be modeled as:
```
L = P(U) * C
```
Where:
*   L = Potential Liability
*   P(U) = Probability of unintended use
*   C = Consequence of the unintended use (financial loss)
Limiting the intended use aims to reduce P(U), thereby reducing the overall potential liability.

C. DEFINING THE SCOPE OF WORK

The scope of work outlines the extent of the appraisal process, including the research, analysis, and reporting required to develop a credible value opinion. It must be sufficient to produce results that are reliable for the intended use. The scope of work determination considers the value standard (e.g., market value, fair value), intended use, and the intended users of the appraisal.

1. Factors Influencing Scope of Work

   a. Complexity of the Property: Complex properties, such as industrial facilities or special-purpose buildings, typically require a more extensive scope of work than simple residential properties. This is because complex properties may require specialized knowledge, data, and analysis techniques.

   b. Data Availability: The availability and reliability of data can significantly impact the scope of work. If reliable data is readily available, the scope of work may be less extensive. Conversely, if data is scarce or unreliable, the appraiser may need to expand the scope of work to gather additional data or perform more in-depth analysis.

   c. Client Requirements: The client’s specific requirements can also influence the scope of work. For example, the client may request a specific type of analysis or report format, which could necessitate adjustments to the scope of work.

2. extraordinary assumption❓s and Hypothetical Conditions

   • An Extraordinary Assumption is an assumption directly related to a specific assignment, which, if found to be false, could alter the appraiser’s opinions or conclusions.

   • A Hypothetical Condition is something known to be contrary to what exists but is used for analysis.

     Example (Extraordinary Assumption): Assuming the subject property has no environmental contamination when the appraiser has not conducted a thorough environmental assessment.
     Example (Hypothetical Condition): Appraising a property as if it were already rezoned for a higher-density use when the rezoning has not yet been approved.

     The potential value change due to the resolution of An extraordinary assumption❓ can be represented as:

     ΔV = V_actual - V_assumed
     Where:
     * ΔV = Change in Value
     * V_actual = Actual Value given all true information
     * V_assumed = Value estimate based on the extraordinary assumption
     The goal is to minimize this value difference through careful research and analysis.

3. Scope of Work Acceptability

   The scope of work must be credible and appropriate for the complexity of the appraisal problem. The scope of work has to conform with both the Uniform Standards of Professional Appraisal Practice (USPAP) and all applicable laws. It’s also the appraiser’s responsibility to inform the client if what the client wants is not what the client needs, i.e. the client’s requirements are beyond what is suitable.

D. ASSUMPTIONS AND LIMITING CONDITIONS

Assumptions and limiting conditions are statements that clarify the basis of the appraisal and define the boundaries of the appraiser’s responsibility. They help the client and other users of the report understand the limitations of the value opinion and avoid unwarranted conclusions.

1. Types of Assumptions

   a. General Assumptions: These are standard assumptions that typically apply to most appraisals, such as the assumption of clear title, compliance with zoning regulations, and the absence of hidden defects.

   b. Specific Assumptions: These are assumptions that are unique to the specific appraisal assignment, such as the assumption that a proposed development will be completed on schedule and within budget.

2. Purpose of Limiting Conditions

   a. Clarifying Scope: Limiting conditions specify the extent of the appraiser’s investigation and analysis. For instance, stating that the appraisal does not include a structural engineering survey.

   b. Defining Responsibilities: Limiting conditions delineate the appraiser’s responsibilities and disclaim liability for matters outside of the appraisal scope. For example, stating that the appraiser is not responsible for legal opinions regarding title.

   c. Managing Risk: Limiting conditions help to manage the appraiser’s risk by clearly stating the limitations of the appraisal and disclaiming liability for unforeseen circumstances.

3. Examples of Limiting Conditions

   • The appraisal is based on information provided by the client and is assumed to be accurate.
   • The appraiser is not qualified to detect the presence of hazardous materials.
   • The appraisal is not a warranty of the property’s condition.
   • The value estimate is only valid as of the effective date of the appraisal.

E. DATE OF APPRAISAL REPORT AND VALUATION DATE

1. Valuation Date

   The valuation date is the specific date as of which the appraiser estimates the value of the property. This date is crucial because market conditions and property characteristics can change over time. It is commonly the date the appraiser inspects the subject property.

2. Date of Appraisal Report

   The appraisal report date is the date the appraiser issues the appraisal report. This date may be the same as the valuation date or a later date, depending on the time required to analyze the data and prepare the report.

3. Importance of Dates

   The client needs to know the appraisal will be issued in time for the client’s decision-making process. The report date shows whether the property is being valued as of the past, present, or future.

F. CONCLUSION

Clearly defining the appraisal assignment by establishing the intended use, scope of work, assumptions, and limiting conditions is essential for producing a credible and reliable appraisal report. This careful definition ensures the appraisal addresses the client’s needs, minimizes the appraiser’s liability, and provides a sound basis for informed decision-making. An understanding of the nuances in this process is fundamental to responsible appraisal practice.