Editor’s Note: July 1, 2006 the new USPAP takes effect. By all accounts the changes are some of the most significant ever as well as some of the most welcome. USPAP instructor and author Lee Hess takes you through a series of common questions and answers to help you shorten the learning curve and keep you working. To purchase “Navigating (New) USPAP,” please see below.
Navigating (New) USPAP
By Lee R. Hess, PhD
For the past five years I have been answering questions about USPAP and how it applies to the everyday work of appraisers. Even veteran appraisers have questions about how USPAP affects their everyday appraising. Effective July 1, 2006, USPAP changes dramatically. The following is excerpted from Navigating USPAP, a new publication with hundreds of questions and answers about the new USPAP and what it means for appraisers (to order see below).
What are the biggest changes that have occurred for 2006?
Conceptually: USPAP now identifies standards that apply in all appraisal assignments. Although the appraiser’s role in the development process has not changed, there are many other significant changes. The new Scope of Work Rule (SOW) replaces the Departure Rule as one of the five rules (Ethics, Competency, Scope of Work, Jurisdictional Exceptions and Supplemental Standards). The new SOW Rule continues to be based on what is required to produce credible assignment results. The term “credible” is also defined so appraisers understand exactly what they are attempting to achieve. Also, the term “appraiser’s peers” has been modified for clarity.
Items Removed: The most important item removed is the Departure Rule. (Is that cheering I hear?) The result is that the Standards Rules no longer contain the terms complete and limited appraisals. SMT 7 (Permitted Departures from Specific Rules) and AO 15, which deals with the same subject, were both retired. According to the Appraisal Standards Board (ASB), these items were taken out to: resolve misunderstandings related to departure; enhance public trust in appraisal practice and to improve the clarity of USPAP.
AO 8, which deals with fair value appraisals, was also retired as the Financial Accounting Standards Board changed its definition of fair value.
Scope of Work Rule: The SOW Rule was added to emphasize the requirements of property identification. Also included are how to determine an appropriate SOW and how to disclose it. New Advisory Opinions were also added. AO 28 was added to give guidance on how to meet the requirements of the new SOW and how to disclose this decision. The ASB includes specific illustrations to clarify the application of these procedures. AO 29 is added to discuss what an acceptable scope of work looks like and how to apply SOW in specific assignments.
Extensive Rewrite: As you can imagine, Departure was mentioned throughout USPAP. Removing it has caused all of the Standard Rules to be revised. You can view all of the changes at The Appraisal Foundation website.
Here are some Specific Questions with Suggested Answers
1. How do I use hypotheticals and extraordinary assumptions?
The best example for a hypothetical condition is to look at a common appraisal problem: appraising a house from a set of plans. The lender has asked you to value this house as if it was constructed (we are assuming something is there for purposes of analysis but we know that the house is not there). This is the hypothetical condition.
Extraordinary assumptions are assumptions you make about the hypothetical. If they are wrong, the appraiser can later revise his appraisal. Regarding the house appraised from the plans: the appraiser assumes it will be built according to plans and specifications; that it will be built in a reasonable time frame and that the real estate market will be similar to what it is as of the date of the appraisal. We don’t know these things for sure but we are making extraordinary assumptions that these conditions will be met.
Other examples of hypothetical appraisals: appraising a house that has burned down (we are assuming for the appraisal that it is there); appraising a property that has construction defects (we start out assuming the property has no defects. This is called the “before condition.”); appraising a property with proposed (not actual) utilities, etc.
You should use extraordinary assumptions every time you appraise a property and report the results on a Fannie Mae 2055 form. You need the assumptions about condition of the property, views, backyard et al.
2. How far do I have to go in describing the property around a house that I am appraising?
AO 23 deals with this subject and indicates that identifying relevant property characteristics enables the appraiser to make a sound SOW decision. In short, the appraiser needs to disclose, disclose, disclose. Do not leave out important aspects about the subject property.
3. I am having trouble understanding some of the terms used in USPAP. Can you define: cadastral, fractional interest, redaction and AVMs?
Cadastral is a common technical term in surveying (and tax collecting), though not widely known outside these specialties. A cadastral survey is one on a scale sufficiently large to accurately show the extent and measurement of every field or other block of land.
The most common reason for such a survey is as a basis for taxation but in some countries, particularly the U.S., it is associated at least as strongly with the need to accurately identify land boundaries. For example, there is an active Cadastral Survey within the Bureau of Land Management in the U.S. which is responsible for maintaining records of all public lands. Such surveys often require detailed investigation of the history of land use, legal accounts and other documents, so it often includes a fair amount of detective work in matching physical surveys with records. The word came into English by way of French and Italian from the Greek “katastikhon,” which is a list or register, from “kata stikhon” or “line by line.”
Fractional Interest, Segment, Partial Interest: You need to understand the meaning of these terms. A fractional interest is land only or the improvements only. A physical segment could be the first floor of a high-rise. A partial interest refers to the bundle of rights that multiple owners have in the property. So you can’t value any of these and then try to extrapolate the value of the whole property.
Redaction: There are two processes that are mentioned in USPAP: redaction and aggregation (see lines 316-318 in USPAP). Redaction is removing confidential information (by black felt pen or some other means). Aggregation is bringing data together from several sources so that it is not recognizable and there is no confidential information. Following one of these two procedures will enable you to send sample copies of appraisals and still meet USPAP.
AVMs: Many appraisers are concerned that AVMs are replacing traditional appraisals. Currently only Fannie Mae and Freddie Mac even attempt this with Desktop Underwriter and Loan Prospector. These two giants combined represent only twenty-five percent of all loans sold. They both require appraisals in the process. AVMs are being used primarily in residential reviews. There are two main approaches to AVMs: Hedonic and Index AVMs. Hedonic AVMs use algorithms and other techniques to apply a form of artificial intelligence. These are similar to the programs that monitor credit card use.
Index AVMs take the last known transfer of the subject property and apply an appreciation (or depreciation) factor based upon historic sales and re-sales in the defined market. The most recent AVMs use a combination of hedonics and indexing.
Individual appraisers can purchase programs or create their own AVMs using regression analysis using programs such as Microsoft Excel and WordPerfect. The important thing for users of AVMs to know is that they are required to understand how AVMs function and the specific limitations of each one they use.
A common question is how can a staff reviewer in one part of the country make an accurate determination on a property thousands of miles away? They typically run an AVM and compare this to the appraisal result. If it is within a specified range, then the appraisal is acceptable. The acceptable range differs from lender to lender.
About the Author
Dr. Lee Hess is a nationally-certified USPAP instructor, expert witness and author of 15 books.