Appraisal Foundations: Regulations & Market Basics

Chapter: Appraisal Foundations: Regulations & Market Basics

Introduction

Real estate appraisal is a complex field requiring a solid understanding of both regulatory frameworks and market dynamics. This chapter lays the foundation for navigating the intricacies of appraisal practice by exploring the roles and responsibilities of key organizations, and delving into the fundamental principles that govern market behavior. We will examine how regulations shape appraisal standards and practices, and how market forces influence property values.

1. The Appraisal Foundation & Its Components

The Appraisal Foundation (TAF) is a non-profit organization chartered by Congress to promote professionalism in the appraisal field. It serves as the umbrella organization for three independent boards, each with distinct responsibilities:

• 1.1 The Appraisal Standards Board (ASB)

  The ASB is responsible for developing, interpreting, and revising the Uniform Standards of Professional Appraisal Practice (USPAP). USPAP sets forth the ethical and performance standards for appraisers.

  • 1.1.1 USPAP Standards and Rules

    USPAP is comprised of several standards, each addressing specific appraisal activities:

    • Standard 1: Real Property Appraisal
    • Standard 2: Real Property Appraisal Reporting
    • Standard 3: Appraisal Review
    • Standard 4: Appraisal Review Reporting
    • (And others for personal property, business appraisal, etc.)

    Each standard is further divided into Standards Rules, which provide detailed guidelines for appraiser conduct.

    • Example: Standards Rule 1-1(a) states: “An appraiser must be competent to perform the assignment.”
      • 1.1.2 Advisory Opinions

    The ASB also issues Advisory Opinions (AOs) to provide guidance on specific appraisal issues. AOs are not part of USPAP, but they offer valuable interpretations and best practices.
    * 1.2 The Appraisal Qualifications Board (AQB)

  The AQB establishes the minimum education, experience, and examination requirements for real property appraisers.

  • 1.2.1 Appraiser Categories

    The AQB defines different categories of appraiser licensure and certification, reflecting varying levels of competency and authorized scope of practice:

    • Trainee Appraiser: Entry-level; works under supervision.
    • Licensed Residential Appraiser: Appraises non-complex 1-4 unit residential properties with a transaction value below a certain threshold.
    • Certified Residential Appraiser: Appraises any 1-4 unit residential property, regardless of transaction value or complexity.
    • Certified General Appraiser: Appraises all types of real property.
      • 1.2.2 Qualification Criteria

    AQB criteria include coursework hours, supervised experience hours, and successful completion of a state-administered exam.
    * 1.3 The Appraisal Practices Board (APB)

  The APB focuses on identifying and issuing opinions on recognized valuation methods and techniques. APB guidance is voluntary and aims to improve appraisal quality.

  • 1.3.1 Valuation Methods and Techniques

    The APB provides insights on various valuation methodologies, such as discounted cash flow analysis, cost❓❓ approach techniques, and sales comparison adjustments.

2. Federal Regulations & Appraisal Independence

The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 mandated appraisal licensing and certification for federally related transactions. FIRREA was a response to the Savings and Loan crisis and aimed to ensure the integrity of the appraisal process.

• 2.1 Federally Related Transactions

  FIRREA applies to appraisals used in connection with loans made by federally insured banks, savings and loan associations, and other financial institutions.
  * 2.2 Appraisal Independence Requirements

  Regulations are in place to prevent undue influence on appraisers. These include:

  • Restrictions on lender influence: Lenders cannot coerce or unduly influence appraisers.
  • Appraiser selection: Appraisers must be selected in an impartial manner.
  • Fee arrangements: Appraisal fees must be reasonable and customary.

  Example: A lender suggesting a specific value to an appraiser is a violation of appraisal independence.
  * 2.3 The Dodd-Frank Act

  The Dodd-Frank Wall Street Reform and Consumer Protection Act further strengthened appraisal independence by prohibiting certain conflicts of interest and promoting appraisal management company (AMC) regulation.

3. Market Fundamentals & Value

Value, in the context of appraisal, is an opinion of the worth of a property at a specific point in time. It is not a fact, but rather a reasoned estimate based on market data and analysis. Understanding market fundamentals is crucial to forming a credible value opinion.

• 3.1 Supply and Demand

  The principle of supply and demand dictates that the price of a good or service, including real estate, is determined by the interaction of these two forces.

  • Mathematical Representation:

    Let:
    * P = Price
    * Qd = Quantity Demanded
    * Qs = Quantity Supplied

    In equilibrium: Qd = Qs

    An increase in demand (Qd increases) while supply remains constant (Qs constant) will generally lead to an increase in price (P increases). Conversely, an increase in supply (Qs increases) while demand remains constant (Qd constant) will generally lead to a decrease in price (P decreases).

  • Factors Influencing Demand: Population growth, income levels, interest rates, consumer confidence.

  • Factors Influencing Supply: Construction costs, land availability, zoning regulations, economic incentives.
  • 3.2 Four Essential Elements of Value

  For a property to have value, it must possess the following four characteristics:

  1. Utility: The ability to satisfy a need or desire.
  2. Scarcity: Limited availability relative to demand.
  3. Demand: The desire and ability to purchase.
  4. Transferability: The ability to convey ownership.
     * 3.3 Principles of Value

  Several economic principles influence real estate value:

  • Principle of Anticipation: Value is based on the expected future benefits of ownership.
  • Principle of Substitution: A buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This principle underlies the sales comparison approach.
  • Principle of Conformity: Value is maximized when properties are similar and compatible in use.
  • Principle of Highest and Best Use: The most probable use of a property that is physically possible, legally permissible, financially feasible, and results in the highest value.

4. Appraisal Approaches to Value

Appraisers typically employ three approaches to value:

• 4.1 Sales Comparison Approach: Based on the principle of substitution, this approach compares the subject property to similar properties that have recently sold. Adjustments are made to the comparable sales prices to account for differences in features, location, and market conditions.
• 4.2 Cost Approach: This approach estimates the cost to reproduce or replace the property, subtracts depreciation, and adds the land value. It is most reliable for new or unique properties.
  • Formula: Value = Cost of Reproduction/Replacement - Depreciation + Land Value

• 4.3 Income Approach: This approach estimates the value based on the property’s potential to generate income. It is primarily used for income-producing properties such as apartments or office buildings.

  • Formula (Direct Capitalization): Value = Net Operating Income (NOI) / Capitalization Rate (Cap Rate)

5. Property Rights & Interests

Real estate appraisal involves understanding the rights and interests being appraised.

• 5.1 Fee Simple Ownership: The most complete form of ownership, granting the owner all rights to the property.
• 5.2 Leasehold Interest: The right to occupy and use a property for a specified period of time, as defined in a lease agreement.
• 5.3 Easements: A right to use another person’s property for a specific purpose.
• 5.4 Liens: A financial claim against a property, such as a mortgage or tax lien.

6. Land Descriptions

Accurate property identification is crucial. Several systems are used to describe land:

• 6.1 Metes and Bounds: Uses distances (metes) and directions (bounds) to define property boundaries.
• 6.2 Lot and Block: Identifies properties within a recorded subdivision plat.
• 6.3 Rectangular Survey System (Government Survey): Divides land into townships, ranges, and sections.

Conclusion

This chapter has provided a foundational understanding of the regulations and market principles that shape the real estate appraisal profession. By understanding the roles of the Appraisal Foundation, the impact of federal regulations, and the fundamental principles of value, aspiring appraisers can begin to develop the knowledge and skills necessary to navigate the complexities of the field. The subsequent chapters will build upon this foundation, exploring specific appraisal techniques and reporting requirements in greater detail.