Appraisal Standards and Regulation

Appraisal Standards and Regulation: Introduction

This chapter provides a comprehensive examination of the appraisal standards and regulatory frameworks governing the appraisal profession. The accurate and reliable valuation of assets is of paramount importance to the stability and efficiency of financial markets, informing decisions related to lending, investment, taxation, and legal proceedings. Erroneous or biased appraisals can lead to significant economic consequences, including market distortions, financial instability, and misallocation of capital. Therefore, the scientific importance of understanding and adhering to robust appraisal standards and regulations cannot be overstated. This chapter will focus on the pivotal role of the Uniform Standards of Professional Appraisal Practice (USPAP) in establishing ethical and performance benchmarks for appraisers. Further, it will review the structure of regulatory bodies, such as state appraiser boards, and their crucial function in ensuring compliance with USPAP and maintaining public trust. We will also review the qualifications and licensing procedures, underscoring the scientific rationale behind these requirements in guaranteeing appraiser competence and impartiality. The recent evolution of appraisal management companies (AMCs) will also be reviewed, in the context of maintaining the independence of the appraiser. The educational goals of this chapter are threefold: (1) to provide a thorough understanding of the principles and specific requirements outlined in USPAP; (2) to familiarize students with the structure and function of appraisal regulatory bodies and their role in enforcing standards; and (3) to enable students to critically evaluate appraisal practices and reports, identifying potential biases or deviations from established standards, thus contributing to more informed and reliable valuation processes.

Chapter: Appraisal Standards and Regulation

I. Introduction

The appraisal profession plays a crucial role in financial markets, providing objective and unbiased opinions of value for various assets, primarily real estate. The integrity and reliability of these opinions are paramount for maintaining market stability and protecting the interests of consumers, lenders, and investors. This chapter delves into the intricate world of appraisal standards and regulations, exploring their history, scientific underpinnings, and practical applications. We will examine the theoretical basis for standardization and the consequences of non-compliance, ultimately understanding how these frameworks contribute to a trustworthy appraisal process.

II. The Need for Standards and Regulation

Prior to the late 20th century, the appraisal industry largely operated without consistent, enforceable standards. This lack of uniformity led to significant variability in appraisal quality and, in some cases, contributed to financial instability. The absence of standards can be explained through various economic and behavioral theories:

• Information Asymmetry: Appraisers possess specialized knowledge that clients often lack, creating an information asymmetry. Without standards, appraisers could exploit this asymmetry, potentially inflating values for personal gain or to satisfy client desires. This can be modeled using game theory, where the appraiser’s dominant strategy might be to prioritize short-term profit over long-term reputation, leading to a suboptimal outcome for the market.

• Moral Hazard: When appraisers are not held accountable for their work, they face a moral hazard. This means they have an incentive to take on excessive risk or engage in unethical behavior because the consequences of their actions are not fully borne by them. For example, if an appraiser knows a lender is desperate to close a deal, they might be tempted to inflate the appraisal, knowing the lender is unlikely to challenge it.

• Adverse Selection: Without regulation, the market attracts appraisers of varying skill levels and ethical standards. Clients, unable to easily distinguish between competent and incompetent appraisers, may unknowingly select subpar professionals. This adverse selection problem can lead to a decline in overall appraisal quality.

The Savings and Loan (S&L) crisis of the 1980s serves as a stark example of the consequences of inadequate appraisal standards. Questionable appraisal practices, including inflated valuations, were identified as a contributing factor to the widespread failures of S&L institutions. This crisis galvanized the industry and the federal government to establish comprehensive standards and regulations.

III. The Appraisal Foundation and its Components

In response to the S&L crisis, key appraisal organizations united to establish the Appraisal Foundation, a non-profit organization dedicated to fostering professionalism and maintaining public trust in the appraisal industry. The Appraisal Foundation is not a government agency, but it has been granted authority by Congress to establish appraisal standards and appraiser qualification criteria. The Appraisal Foundation comprises three independent boards:

• A. Appraisal Standards Board (ASB): The ASB is responsible for developing, interpreting, and updating the Uniform Standards of Professional Appraisal Practice (USPAP). USPAP is the ethical and performance standard for appraisers. The ASB also issues Statements on Appraisal Standards and Advisory Opinions to provide guidance on specific appraisal issues.

  • Scientific Basis: The ASB’s work relies on principles of statistical analysis, market analysis, and real estate economics. For example, when developing standards for the sales comparison approach, the ASB draws upon statistical techniques like regression analysis to ensure that adjustments for differences between comparable properties are supported by market data.

  • Example: An advisory opinion might address the proper methodology for valuing a property with environmental contamination. The ASB would consider scientific literature on the impact of contamination on property values and incorporate established risk assessment models into its recommendations. For example, the value decline (VD) can be estimated using:

  VD = f(C, P, M, D)

  Where:
  * C = Cost to remediate.
  * P = Perceived risk by buyers.
  * M = Market conditions.
  * D = Discount rate.

• B. Appraiser Qualifications Board (AQB): The AQB establishes the minimum education, experience, and examination requirements for appraiser licensing and certification. These requirements are designed to ensure that appraisers possess the necessary knowledge and skills to perform competent appraisals.

  • Scientific Basis: The AQB’s qualification criteria are based on principles of adult learning and competency-based education. The AQB uses job analysis studies and surveys of experienced appraisers to identify the key competencies required for successful appraisal practice. These competencies are then translated into specific education and experience requirements.

  • Example: The AQB specifies the number of hours of coursework required in subjects such as real estate appraisal principles, valuation methodologies, and USPAP. It also requires supervised experience under a qualified mentor to ensure that trainees develop practical skills and ethical judgment. As seen in Figure 14-3, the AQB continually updates its Real Property Appraisal Qualifications criteria, with increasing college education requirements for licenses.

• C. Appraisal Practices Board (APB): This board was founded to codify and implement the best practices for appraisers in the field.

IV. The Uniform Standards of Professional Appraisal Practice (USPAP)

USPAP is the cornerstone of appraisal standards in the United States. It represents a consensus-based framework for ethical behavior and competent appraisal practice. USPAP is regularly updated to reflect changes in the industry and legal requirements.

• A. Structure of USPAP: USPAP consists of the following key elements:

  1. Preamble: Provides an overview of USPAP and its purpose.
  2. Ethics Rule: Sets forth ethical obligations related to conduct, management, confidentiality, and record keeping. This incorporates the principles of ethical decision-making from the field of behavioral economics, recognizing the potential for cognitive biases and conflicts of interest to influence appraisal judgments.
  3. Competency Rule: Requires appraisers to have the necessary knowledge and experience to perform appraisal assignments competently.
  4. Scope of Work Rule: Requires appraisers to identify the problem to be solved, determine the scope of work necessary to develop credible assignment results, and disclose the scope of work in the appraisal report.
  5. Jurisdictional Exception Rule: Allows for deviations from USPAP when required by law or regulation.
  6. Definitions: Provides precise definitions of terms used in USPAP.
  7. Standards Rules 1-10: Each of the ten Standards focuses on a specific aspect of the appraisal process, from developing an appraisal to reporting the results.

• B. Key Principles Embodied in USPAP:

  • Objectivity: Appraisals must be unbiased and based on factual data, not personal opinions or external pressures.

    • Example: An appraiser must not allow a client’s desired value to influence their analysis or conclusions. They should rely on market data and accepted valuation methodologies.

  • Independence: Appraisers must be free from undue influence from any party involved in the transaction.

    • Example: Federal regulations now require banks to have a “firewall” between lenders and appraisers through the use of AMC’s, ensuring that lenders cannot directly pressure appraisers to inflate values.

  • Competence: Appraisers must possess the necessary knowledge, skills, and experience to perform appraisal assignments competently.

    • Example: An appraiser specializing in residential properties should not accept an assignment to appraise a complex industrial facility without seeking assistance from a qualified expert.

  • Due Diligence: Appraisers must conduct thorough research and analysis to develop credible appraisal results.

    • Example: An appraiser should verify the accuracy of all data used in the appraisal, including property characteristics, sales comparables, and market trends.

  • Confidentiality: Appraisers must protect the confidentiality of client information.

    • Example: Appraisers must not disclose appraisal results or other confidential information to unauthorized parties.

• C. USPAP Compliance: Compliance with USPAP is essential for appraisers. Failure to comply can result in disciplinary actions, including license suspension or revocation, and legal liability.

  • Experiment: Conduct a “mock” appraisal review where different appraisers evaluate the same property using a provided dataset, but some are given a specific (and unrealistic) target value to try and hit. Analyze the results to see how varying compliance with USPAP affects the final valuations. Examine if appraisers with no target value reach similar conclusions.

V. Federal and State Regulation of Appraisers

In addition to USPAP, appraisers are subject to federal and state regulation.

• A. Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989: FIRREA mandated the licensing and certification of appraisers for federally related transactions. This legislation aimed to improve the quality and reliability of appraisals used in connection with mortgage lending and other financial activities.

  • Impact: FIRREA led to the establishment of state appraiser regulatory agencies and the development of standardized licensing and certification requirements.

• B. State Appraiser Regulatory Agencies: Each state has an agency responsible for licensing, regulating, and disciplining appraisers. These agencies enforce state appraisal laws and regulations, which typically incorporate USPAP requirements. As shown in Figure 14-6, each state has their own agency with different requirements.

  • Role: State agencies investigate complaints against appraisers, conduct disciplinary hearings, and impose sanctions for violations of appraisal laws and regulations.

• C. Appraisal Management Companies (AMCs): AMCs act as intermediaries between lenders and appraisers, managing the appraisal process and ensuring appraiser independence. Federal regulations require lenders to use AMCs to prevent undue influence on appraisers.

  • Mathematical Representation: Let’s consider a simple model of the appraisal process with an AMC:

  V_A = V_T + e

  Where:
  * V_A = Appraisal Value.
  * V_T = True Market Value (often unknown).
  * e = Error term (representing random error and potential bias).

  The presence of an AMC aims to minimize the systematic component of the error term (e) that might be introduced by lender influence. Without an AMC, the error term could be positively correlated with the lender’s desired outcome.

VI. Professional Appraisal Organizations

Numerous professional appraisal organizations exist, such as the American Society of Appraisers (ASA), and the National Association of Independent Fee Appraisers (NAIFA) shown in Figure 14-2. These organizations offer education, certification programs, and resources for appraisers. Membership in a professional organization can enhance an appraiser’s credibility and demonstrate a commitment to professional development. However, it is vital to note that adherence to USPAP and state/federal regulations are paramount, regardless of organizational affiliation.

VII. Conclusion

Appraisal standards and regulations are essential for maintaining the integrity and reliability of the appraisal process. USPAP provides a comprehensive framework for ethical behavior and competent appraisal practice, while federal and state regulations ensure that appraisers are qualified and accountable. The ongoing evolution of appraisal standards reflects the dynamic nature of the real estate market and the importance of adapting to new challenges and technologies. By understanding and adhering to these standards and regulations, appraisers can contribute to a more stable and transparent financial system.

VIII. Review Questions

1. Explain the role of the Appraisal Foundation and its three boards.
2. Describe the key principles embodied in USPAP.
3. Discuss the impact of FIRREA on the appraisal profession.
4. What is an Appraisal Management Company (AMC) and how does it contribute to appraiser independence?
5. What are the potential consequences of violating USPAP or state appraisal laws?