Appraisal Limitations and Certification: Scope, Assumptions, and Responsibilities

Chapter: Appraisal Limitations and Certification: Scope, Assumptions, and Responsibilities

Introduction

This chapter delves into the critical aspects of appraisal limitations, certifications, scope, assumptions, and responsibilities. A comprehensive understanding of these elements is paramount for appraisers❓ to conduct credible valuations and for users of appraisal reports to interpret the findings appropriately. We will explore the underlying scientific principles, ethical considerations, and legal ramifications associated with each component. This chapter also discusses potential issues with standardized appraisal forms, such as those used for Fannie Mae/Freddie Mac appraisals, and the appraiser’s responsibility to supplement these forms when necessary.

I. Scope of Work

A. Definition and Importance

The scope of work encompasses the extent and type of research and analyses conducted in an appraisal assignment. It defines the boundaries of the appraiser’s investigation and sets the parameters for the valuation. The scope of work must be identified and disclosed in the appraisal report.

B. USPAP Requirements

Uniform Standards of Professional Appraisal Practice (USPAP) requires that the scope of work be sufficient to produce credible assignment results. It includes identifying the problem to be solved, determining the scope of work necessary to solve the problem, correctly completing research and analysis, and properly reporting the result.

C. Elements Defining Scope

1. Property Characteristics: Identifying relevant property characteristics, such as size, condition, zoning, and environmental factors. For example, determining the exact square footage (A) of a property and the lot size (B) can be described mathematically: Property Area = A + B. Discrepancies found in public records or prior appraisals must be investigated.

2. Data Sources: Specifying the sources of information used in the appraisal, including market data, property records, and expert consultations.
   a. Market Data Analysis: Gathering and analyzing relevant market data, such as comparable sales, listings, and market trends. Appraisers might use regression analysis to determine the influence of each variable on the final price. For example, Price = b0 + b1X1 + b2X2 + … + bnXn, where b0 is the intercept, and b1 to bn are the coefficients for the independent variables X1 to Xn.

3. Valuation Approaches: Selecting and applying appropriate valuation approaches, such as the sales comparison approach, cost approach, and income capitalization approach.

4. Reporting Requirements: Detailing the level of detail and format of the appraisal report.

D. Scope Limitations

1. Definition: Scope limitations are restrictions or constraints that affect the appraiser’s ability to perform a complete and thorough analysis.

2. Disclosure: All scope limitations must be clearly disclosed in the appraisal report. The disclosure should include the nature of the limitation and its potential impact on the appraisal’s credibility.

3. Examples:
   a. Limited Property Inspection: Restricted access to certain areas of the property may prevent a comprehensive inspection.
   b. Data Availability: Insufficient or unreliable data may limit the appraiser’s ability to develop credible opinions and conclusions.

E. Scope of Work in Practice: Sales Comparison Approach

1. Selection of Comparable Sales: Appraisers need to research the market to find the most similar sales to the subject property. Criteria for selecting comparable sales include location, property type, size, age, condition, and date of sale.
2. Adjustment Process: Once the comparable sales are identified, adjustments are made to account for differences between the comparable sales and the subject property. These adjustments should be based on market evidence.
   Adjustment = Sale Price * (Percentage Adjustment / 100)
3. Reconciliation: After the adjustments are made, the appraiser reconciles the adjusted sales prices of the comparable sales to arrive at an indicated value for the subject property.

II. Appraisal Assumptions

A. Definition and Types

Assumptions are statements that are taken to be true for the purpose of the appraisal. Assumptions are not facts, but rather suppositions that are made to facilitate the valuation process. There are two primary types of assumptions:

1. Ordinary Assumptions: These are typical assumptions that are commonly made in appraisal practice, such as the assumption that the property will be used for its highest and best use, or that the information relied upon is accurate.

2. Extraordinary Assumptions: These are assumptions that are made because of specific circumstances that are unusual or extraordinary. An example is assuming a property is free of environmental contamination when there is no data to support that assumption.

B. Impact on Valuation

Assumptions can significantly affect the reliability of the appraisal. Appraisers must carefully consider the potential impact of their assumptions and disclose them in the appraisal report.

C. Examples:

1. Work in Progress: The appraiser often assumes that work in progress will be completed in a professional manner.

2. Hidden Conditions: Appraisers typically assume that there are no hidden and unapparent adverse conditions. However, they are not building inspectors, engineers, or environmentalists, and cannot guarantee the absence of such conditions.

D. Mathematical Model: The Influence of Assumptions in Discounted Cash Flow (DCF) Analysis

1. DCF: In income-producing property valuations, DCF is often used. This model is highly sensitive to assumptions about future cash flows, discount rates, and terminal values.
2. Formula:
   Present Value = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + … + CFn / (1 + r)^n + TV / (1 + r)^n
   Where:
   CFn is the cash flow in year n,
   r is the discount rate, and
   TV is the terminal value (the value of the property at the end of the projection period).

The reliability of the final appraised value directly depends on the accuracy of these assumptions. Even small changes in the discount rate or cash flow projections can lead to significant changes in the final valuation.

III. Appraisal Limitations

A. Definition

Limitations are factors that restrict the appraiser’s ability to perform a complete and accurate valuation. These can arise from various sources, including:

1. Data Limitations: Insufficient or unreliable data.

2. Legal Limitations: Restrictions imposed by laws, regulations, or contractual agreements.

3. Physical Limitations: Restrictions on access to the property or portions thereof.

B. Disclosure Requirements

USPAP requires appraisers to disclose all limitations that affect the appraisal’s scope or accuracy.

C. Examples

1. Flood Maps: Appraisers often rely on FEMA flood maps but do not guarantee their accuracy.
2. Legal Issues: The appraiser is not a legal expert and cannot provide legal advice.
3. Environmental Issues: The appraiser is not an environmental expert and cannot guarantee the absence of environmental contamination.

D. Dealing with Limitations: An Experimental Approach

1. Scenario: Suppose an appraiser faces data limitations in determining the appropriate cap rate for an income-producing property.
2. Experiment: The appraiser can conduct a sensitivity analysis to understand how changes in the cap rate affect the property’s value.
3. Sensitivity Analysis: Value = Net Operating Income (NOI) / Cap Rate. By varying the cap rate within a reasonable range, the appraiser can determine the potential range of values for the property. This helps to mitigate the uncertainty caused by the data limitation.

IV. Appraiser’s Responsibilities

A. Ethical Obligations

Appraisers have a responsibility to act ethically and professionally in all aspects of their work. This includes:

1. Competency: Possessing the necessary knowledge and skills to perform the appraisal assignment competently.

2. Objectivity: Maintaining an unbiased and impartial perspective.

3. Confidentiality: Protecting confidential information.

B. Legal Obligations

Appraisers must comply with all applicable laws and regulations, including USPAP, state appraisal laws, and federal lending regulations.

C. Liability

Appraisers can be held liable for errors, omissions, or misrepresentations in their appraisal reports.

D. Certification

Appraisers’ certifications attest to their compliance with USPAP and other relevant standards. The appraiser must certify that:

1. The appraisal was performed in accordance with USPAP.

2. The appraiser has the necessary competency to perform the assignment.

3. The appraiser has no present or prospective interest in the property.

4. The appraiser has not knowingly withheld any significant information from the report.

E. Testifying and Court Appearances

1. Conditions: Appraisers will only testify in court if arrangements are made in advance.

2. Expert Witness Standards: Appraisers who testify as expert witnesses must adhere to strict standards of objectivity and accuracy.

V. Appraiser’s Certification: Detailed Analysis of Paragraphs

(Referring to the numbered paragraphs as they are in the provided source material)

A. Scope of Work Adherence (Paragraph 1)

The appraiser followed the Scope of Work: This affirms that the appraiser stayed within the boundaries defined for the assignment.

B. Property Inspection (Paragraph 2)

The appraiser viewed both the interior and exterior of the subject property: This confirms that a physical inspection, as defined in the scope of work, was performed.

C. USPAP Compliance (Paragraph 3)

The appraiser followed the current USPAP requirements: This certification is fundamental and crucial.

D. Valuation Approaches (Paragraph 4)

The appraiser only utilized the sales comparison approach…: This is a disclosure of which approaches were considered and why.

E. Subject Property History (Paragraph 5)

The appraiser noted all listings of the subject property within the past 12 months…: This shows due diligence in researching the property’s sales history.

F. Comparable Sales History (Paragraph 6)

The appraiser noted all prior sales of the comparables for the past 12 months: Again, this shows attention to detail.

G. Comparable Selection (Paragraph 7)

The appraiser utilized the most similar comparable sales: This asserts that the best available data was used.

H. “Put-Together” Sales (Paragraph 8)

The appraiser is not supposed to add up the cost of the land and the improvements from two separate contracts and call it market value: This specifically addresses an improper appraisal technique.

I. Market-Based Adjustments (Paragraph 9)

Adjustments must be based on market reactions: Adjustments need to be grounded in empirical evidence, not arbitrary figures.

J. Verification of Information (Paragraph 10)

All information provided by anyone with an interest in the property must be verified by parties that are “arm’s length.” This confirms that the appraiser has verified that information.

K. Competency Certification (Paragraph 11)

The appraiser certifies that he/she has both geographic competency and the necessary competency to appraise the property type: This is a critical self-assessment.

L. Data Availability (Paragraph 12)

The appraiser is aware of and able to obtain all necessary data to perform a credible report: The appraiser has access to the resources needed.

M. Data Reliability (Paragraph 13)

Any data provided by others that is utilized in the report is believed to be reliable and correct: While not a guarantee, this states the appraiser’s belief in the accuracy of the used information.

N. Adverse Conditions (Paragraph 14)

If any adverse conditions were either seen by or made aware of to the appraiser, they have been listed in the report and their effect on value has been analyzed: Acknowledgment and analysis of property flaws.

O. Truthfulness (Paragraph 15)

The appraiser has not knowingly withheld information and the statements and information contained in the report are true and correct to the best of the appraiser’s knowledge: A declaration of honesty and good faith.

P. Impartiality (Paragraph 16-17)

The appraiser is not biased. … The appraiser has no current or future interest in the property being appraised. Further, the appraiser has no bias as to race, religion, color, sex, marital status, handicap, familial status, or national origin of any of the parties involved: Assurance of objectivity and fairness.

Q. Predetermined Outcomes (Paragraph 18)

No predetermined values. No predetermined results: The appraiser worked independently of any target values.

R. Independent Work (Paragraph 19)

The appraiser did his/her own work… No one is allowed to make any changes in the appraiser’s work and any such changes are unauthorized: This ensures the integrity of the valuation process.

S. Client Identification (Paragraph 20)

The lender/client is identified in the report. …This clarifies the intended user of the appraisal.

T. Report Distribution (Paragraph 21-23)

These paragraphs outline who can receive and rely on the appraisal report. According to the document, the borrower is now an intended user and can request to see the report.

U. Signature (Paragraph 24)

States that a report with either an “electronic signature” from a computer or a facsimile signature from a fax machine is the same as an “original ink signature” from an appraiser: This establishes the validity of digital signatures.

V. Federal Law (Paragraph 25)

No intentional or negligent misrepresentations are allowed by federal law: A reminder of legal consequences for inaccurate or misleading information.

VI. Addressing Standardized Appraisal Forms

A. Form Limitations

Appraisal forms, such as those used by Fannie Mae/Freddie Mac, may not always be adequate to capture all relevant information or to address the specific complexities of a property.

B. USPAP Compliance

USPAP requires appraisers to supplement a report form when necessary to ensure that the intended users of the appraisal are not misled and that the report complies with the applicable content requirements.

C. Examples of Supplementation

1. Complex Properties: Supplement the form with additional analysis and documentation to address the unique characteristics of a complex property.

2. Market Conditions: Provide additional commentary on local market conditions to supplement the standardized form.

3. Disclosure of Assumptions and Limitations: Clearly disclose any assumptions and limitations that are not adequately addressed in the standardized form.

D. Documentation

All supplemental information should be clearly labeled and integrated into the appraisal report.

VII. Conclusion

A thorough understanding of appraisal limitations, certifications, scope, assumptions, and responsibilities is essential for credible valuations. Appraisers must adhere to USPAP guidelines, act ethically, and exercise sound judgment in all aspects of their work. The proper identification and disclosure of limitations and assumptions are critical for ensuring that appraisal reports are reliable and can be properly understood by their intended users. It is important for appraisers to adapt their processes to make sure that standardized appraisal forms used in practice are supplemented when needed to ensure compliance with all applicable appraisal principles.