Appraisal Reviews
The primary purpose of an appraisal review is to reinforce the clients confidence in an appraisal report's reliability and conclusions. It is essentially a quality control function.
The Federal Reserve states that financial institutions "must have an effective, independent real estate evaluation program, which ensures the independence of the collateral valuation process, and maintains safe and sound banking practices." "At a minimum, a banks appraisal review policies and procedures should specify:
the reviewer's qualifications, including experience, education, training and independence from the loan production function;
the timing of reviews so that they are completed before credit decisions are made;
the scope of the appraisal review, which will vary according to transaction type, risk, size, and complexity - the review must always be adequate to determine whether the appraisal is complete, the reported value reasonable, and the appraiser's techniques adequate and well supported;
standards for documenting the review and communicating its findings, including processes for resolving inaccuracies, appraisal weaknesses, and ambiguities; rejecting appraisals; and referring potential fraudulent activity to the appropriate regulator; and
relevant audit and control processes." (Lynn Woosley, Atlanta Fed's Supervision and Regulation Department)
All public and private entities that commission appraisal reports on a regular basis should have an effective appraisal evaluation process in place.
Appraisal reviews are largely determined by the scope of work often involve appraisal review "forms" but a narrative format may be more appropriate based on client needs.
An appraisal review can be narrow or limited and determine only whether an appraisal report meets minimum appraisal standards (12 CFR 323.4), basic compliance with USPAP Standards Rule 2-2, that mathematical calculations are presented clearly and accurately, report sections are consistent and reconcile without contradictory information and the value conclusion reconciles with the value range from approaches used and is logical. This report can be in a restricted use format, a review appraisal "form", or a narrative format depending on client needs.
A more comprehensive appraisal review may involve detailed examination of every element of an appraisal report. It encompasses all that is cited in the previous paragraph but goes into greater detail and may involve communication with the appraiser, suggested corrections or revisions either to comply with USPAP and/or client appraisal report guidelines (that exceed USPAP minimum requirements), and assessing/resolving qualitative issues. It may involve providing the client with an opinion of value in which case the review appraiser is required to fully comply with USPAP Standard 1.
USPAP Advisory Opinion 20, line 53: Appraisers sometimes use such terms as "Desk Review", "Field Review", "Complete Review", "Limited Review", "Technical Review", and "Administrative Review". However, without appropriate explanation, these terms and phrases can result in misunderstanding about the function being performed by a reviewer. While such terms may be convenient labels for use in a business setting, they do not necessarily impart the same meaning in every situation.
We perform appraisal reviews with a limited scope of work nationwide as well as more comprehensive appraisal reviews involving physical inspection of a property and neighborhood and/or providing the client with an opinion of value. Appraisal reviews requiring physical inspections are performed only in Eastern Massachusetts and Southern New Hampshire.
In Policy Statement 5, the ASC (Appraisal Subcommittee), "has concluded that for federally regulated transactions the review appraiser need not register for a temporary practice or otherwise be subjected to the regulatory jurisdiction of the State agency in which the appraisal was performed, so long as the review appraiser does not perform the technical review in the State within which the property is located" (unless of course they are licensed in that state).
Some of the Most Common Errors in Appraisal Reports
Failure to provide sufficient analyses in Summary Appraisal Reports. Per USPAP Standards Rule 2-2, the appraiser must "summarize the information analyzed, the appraisal methods and techniques employed, and the reasoning that supports the analyses, opinions, and conclusions". A summary report must provide enough information to allow the reader to understand the rationale supporting the appraiser's analyses, opinions and conclusions. This normally requires at least a paragraph and can rarely be accomplished in a single sentence.
Problems with Highest and Best Use. The appraiser must separately address property uses that are physically possible, legally permissible, financially feasible, and maximally productive. Simply stating that the property is currently developed to it's highest and best use does not comply with USPAP Standards Rule 1-3. Also there can be a failure to address propertry characteristics that may have been mentioned in the site or building descriptions. There are many obvious property issues that trigger additional highest and best uses analysis - excess land, surplus land, a legally non-conforming use, obsolescence, the need for renovation or conversion of use, interim use, and transitional use to name a few.
Per USPAP Standards Rule 1-6, "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 approaches, methods and techniques used to arrive at the value conclusion(s)." Again, these requirements cannot be accomplished in one or two sentences.
Errors in the measurement of land and improvements
Failure to adequately account for the condition of the property (i.e. not making proper deductions for deferred maintenance or not accounting for defferences in property condition of the subject and comparables.
Failure to reconcile projected or estimated effective income with subject property's actual operating history. For example, if a property being appraised is not actually achieving effective (gross or net) income of $500,000 and the appraiser has estimated effective gross or net income of $600,000 in the Income Approach, there should be a detailed and plausible explantation supporting this disparity.
Failure to reconcile projected or estimated expenses with subject property's actual expenses.
Failure to investigate all tax assessments imposed on a property. Some jurisdictions have special assessments that appraiser's erroneously overlook. In other instances an appraiser may not investigate assessments on comparable properties to determine if a property is appropriately assessed or if there is a clear trend of increasing or decreasing property assessments or tax rates. The same is true for public budget expansions and changes in utility rates.
Failure to verify that capitalization rates for comparable properties are calculated in the same manner applied to the appraised property. Does the cap rate assume stabilized occupancy when the comparable was operating below stabilized occupancy? Is it based on forward income projections, current (annualized income), or prior years income and expenses? Were leasing commissions or reserves for replacement of short-lived items included or excluded in the operating expenses. An entire web page could be devoted to this topic. One must compare "apples to apples and oranges to oranges" in both the Sales Comparison Approach and Income Approach.
Improperly handling or ignoring excess land.
Failing to recognize the market for the property - local, regional, national?
Valuing a leased fee interest without knowing or analyzing the lease terms
Using multitenant comparables to analyze a single tenant, owner-occupied property
Failing to recognize the dates leases were initiated in comparable rent/lease analysis
Using the DCF method when direct capitalization is more appropriate and vice-versa
Not understanding what is included in Marshall Valuation Costs
Applying adjustments in an improper sequence
Very few financial institutions and other firms that order commercial appraisals on a regular basis require that the appraiser include the name and telephone number (or e-mail address) of the person verifying each sale and lease/rent comparable. Amending an appraisal engagement agreement to include this information as a mandatory requirement (or an explanation for its exclusion in a particular comparable) often results in accross the board improvement in the quality of commercial appraisal reports. Most appraisers will put more time and effort into this primary research if the quality of the data can be easily assessed and verified.
Stephen Bullock, MAI, MRICS is responsible for 100% of the content of all appraisal review assignments.