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Editor’s Note: This article, taken from the print edition of Working RE (Spring 2015), covers the key portions of Standards Rule 1.
Understanding USPAP Part 2: SR – 1
by Phil Spool, ASA
For the most part, all real estate appraisers must abide by Standards Rules 1 and 2. Standards Rule 1 is about the development of the appraisal and Standards Rule 2 is about the report itself. USPAP only defines appraisal, not appraisal report. The definition of appraisal is “The act or process of developing an opinion of value.” The fifth edition of the Dictionary of Real Estate Appraisal by the Appraisal Institute has the same definition. However, only the Dictionary of Real Estate Appraisal has a definition of appraisal report, which is defined as “The written or oral communication of an appraisal.” So when speaking to your client, state that you will be doing an appraisal and preparing an appraisal report.
Standards Rule 1-1: In developing a real property appraisal, an appraiser must:
(a) “be aware of, understand, and correctly employ those recognized methods and techniques that are necessary to produce a credible appraisal;”
(b) “not commit a substantial error of omission or commission that significantly affects an appraisal;” and
(c) “not render appraisal services in a careless or negligent manner, such as by making a series of errors that, although individually might not significantly affect the results of an appraisal, in the aggregate affects the credibility of those results.”
Regarding SR 1-1 (a), neither USPAP nor the Appraisal Institute’s Dictionary of Real Estate Appraisal defines methods and techniques. After discussions with several AQB USPAP instructors, the general consensus is that the term methods typically pertains to the three approaches to value: cost, sales and income, while the word techniques typically pertains to the analysis within each approach.
Within the cost approach, it is the way an appraisal obtains site value, replacement cost new and the calculation of depreciation and obsolescence. Within the sales comparison approach, it is the determination of the unit of comparison of the sales to the subject. It may be the price per unit, price per square foot, etc.
Regarding the income approach, if it is a residential property up to four units, the technique may use a gross rent multiplier. For commercial properties, it may utilize direct capitalization (the use of a property’s single year net operating income by applying an overall capitalization rate) or a cash flow analysis- incorporating several years of net operating income with a reversion or net sale of the property and applying a discount rate over those years under analysis.
Error of Omission/Commission
Standards Rules 1-1 (b) and 1-1 (c) go hand-in-hand. Regarding SR 1-1 (b), what is considered a substantial error of omission or commission? An example of a substantial omission would be to exclude stating that the subject property suffers from deferred maintenance or has functional or external obsolescence. It could be unintentional or intentional. Either one is a violation of USPAP if it significantly affects the opinion and conclusion of the appraiser. Regarding SR 1-1 (c), an example would be a mistake in reporting the gross living area size or the calculation of the gross living area size. In one lawsuit in which I represented the buyer, the appraiser had inadvertently transposed the numbers in the gross living area (3,625 square feet when the actual gross living area should have been 3,265 square feet). If the wrong gross living area is stated and utilized and if that wrong number is relied upon throughout the report to come to a conclusion of value, that is a clear violation of SR 1-1 (c). If the wrong gross living area is stated but the correct size is utilized in determining the value of the subject, then there is a good chance that the appraiser’s mistake is not a violation of SR 1-1 (c). In the above lawsuit case, it was settled through mediation.
The comments section right below SR 1-1 (c) states that “perfection is impossible to attain, and competence does not require perfection.” Let’s be clear about this. Mistakes may not affect value or be a violation of USPAP SR 1-1 (b) or (c), but it will affect the reliability of your report, reflect your lack of proofreading your report and ultimately reduce your credibility and your client’s reliance on your work. A mistake in one section of the report, by putting in the year 2014 instead of 2015, may not be a violation but to put 2014 throughout the entire report and then failing to use the proper year (2015), does make a difference and would more than likely be a violation of USPAP.
Standards Rules 1-1 (b) and 1-1 (c) are extremely important if you are charged with fraud. Most E&O policies have a “fraud” exclusion that excludes coverage in the event of fraud (dishonest, fraudulent, criminal or malicious act or omission, or intentional misrepresentation).
Standards Rule 1-2 is similar to Standards Rule 2-2 and is discussed in detail later in this article. I suggest you read SR 1-2 but also see how it relates to SR 2-2 regarding stating the information within your report.
Standards Rule 1-3 (b): “Develop an opinion of the highest and best use of the real estate.” This statement is very important as it also relates to Standards Rule 2-2 (a) (x): “When an opinion of highest and best use was developed by the appraiser, summarize the support and rationale for that opinion.” Many appraisers do not know or understand that the Highest and Best Use analysis is a two-step process. Step One, develop the opinion. Step Two, summarize that opinion in the report. Merely checking a box does not meet these requirements. This will be discussed in detail in the discussion of SR 2-2 (a) (x).
Standards Rule 1-4: “In developing a real property appraisal, an appraiser must collect, verify, and analyze all information necessary for credible assignment results.” This is the only statement in USPAP that even mentions verify or verification. Ironically, verification of the information the appraiser obtains is very important, yet so many appraisers do not verify sales or other important data that they rely on. Verification will clarify the information stated in public records, especially the grantor and grantee if either one is a corporation or a partnership. It is also important in clarifying the information stated in the Multiple Listing Service (MLS). Also important is the collection and analysis of information the appraiser is able to obtain. Today, more and better information is available on the Internet.
There are only a few statements in Standards Rule 1 of USPAP discussing the analysis of information necessary for credible assignment results, regarding developing a real property appraisal. This includes SR 1-3 (a), all of SR 1-4 and SR 1-5.
Standards Rule 1-5 (a) states “analyze all agreements of sale, options, and listings of the subject property current as of the effective date of the appraisal and (b) analyze all sales of the subject property that occurred within the three (3) years prior to the effective date of the appraisal.”
Keep in mind that the analysis of comparable sales within one year prior to the effective date of the appraisal is a Fannie Mae guideline, not a USPAP requirement. In fact, USPAP does not get into how the analysis of comparable sales should be done.
While the proper way to make adjustments to the comparable sales is a topic of great interest today, nowhere in USPAP does it state how adjustments should be made. It says only to “analyze such comparable sales data as are available to indicate a value conclusion.” In fact, the only places in USPAP where the word “support” is used are in the Records Keeping Rule, regarding the workfile (fourth bullet): “all other data, information, and documentation necessary to support the appraiser’s opinions and conclusion …” (USPAP lines 321 through 323), the Scope of Work Rule: “Credible assignment results require support by relevant evidence and logic” (USPAP lines 402 – 403), and the Scope of Work Acceptability: “An appraiser must be prepared to support the decision to exclude any investigation, information, method, or technique that would appear relevant to the client, another intended user, or the appraiser’s peers” (USPAP lines 438 – 440).
While USPAP does not specifically mention how to support the adjustments to comparable sales, the Records Keeping Rule requiring “to support the appraiser’s opinions” is the most compelling. For some reason, many appraisers will argue that since an appraisal is merely an opinion, adjustments are merely opinions. Nonetheless, the excuse that adjustments are opinions and don’t require or can’t be supported reflects on the appraiser’s quality (or lack thereof) of their work product.
The Fannie Mae Handbook for Appraisers specifically mentions adjustment to comparable sales. It states “In the sales comparison approach, each comparable sale is analyzed for differences and similarities between it and the subject property. You must base your analysis and any adjustments to the comparable sales on the market date for the neighborhood and for competing locations.” In other words, adjustments are location specific. Looking over Fannie Mae guidelines, there is no specific mention of how you go about quantifying adjustments- that is why many seek the help of experts on this topic. Ironically, quantifying adjustments is mentioned but only in the appraisal books used to teach the basic appraisal coursework required to become an appraiser.
Fannie Mae and Adjustments
As of January 26, 2015, new requirements took effect for appraisers regarding what dollar adjustments are made in the sales comparison approach when preparing an appraisal report using the UAD format for Fannie Mae. While most residential appraisers have clients that are either an appraisal management company (AMC) or the lender directly, having to explain your adjustments is only a Fannie Mae requirement, especially if they differ from other appraisals performed by you or other appraisers. While USPAP’s Scope of Work Rule mentions credible assignment results that require support by relevant evidence and logic, nowhere does Standards Rule 1 specifically mention adjustments. The Scope of Work in your report explains the type and extent of research and analyses in an appraisal but it does not mention how adjustments are made. (See Importance of a Good Scope of Work).
Standards Rule 1-6: In developing a real property appraisal, an appraiser must:
(a) “reconcile the quality and quantity of data available and analyzed within the approaches used”; and
(b) “reconcile the applicability and relevance of the approaches, methods and techniques used to arrive at the value conclusion(s)”
While SR 1-6 (a) relates to the quality and quantity of the information you provide, SR 1-6 (b) relates to the importance of the approach(es) to value you utilize and which approach is considered more relevant than the others. Reconciliation is done throughout the appraisal process, whether it is the determination of the site value and reconciling the sales within the sales comparison approach or reconciling the approaches used. Many appraisers consider a weighted average for their conclusion.
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