FIRREA & Appraisal Standards: Regulations and Professionalism

Chapter: FIRREA & Appraisal Standards: Regulations and Professionalism

I. Introduction

This chapter delves into the critical intersection of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and the establishment of appraisal standards. We will explore how FIRREA responded to the Savings and Loan crisis by mandating appraisal regulation, the role of the Appraisal Foundation, and the ensuing development of professional standards within the appraisal industry. A key focus will be understanding how these regulations promote professionalism and maintain public trust.

II. The Genesis of FIRREA and Appraisal Regulation

A. The Savings and Loan Crisis: A Catalyst for Change

The Savings and Loan (S&L) crisis of the 1980s exposed significant weaknesses in the financial system, including lax lending practices and inadequate oversight. Many attributed the crisis, in part, to inflated or unreliable appraisals that masked the true risk associated with real estate loans. Questionable appraisal practices and a lack of industry standards for competence and professional conduct were viewed by many as having contributed to the S&L failures.

B. FIRREA: A Legislative Response

FIRREA was enacted in 1989 as a comprehensive effort to reform the banking industry and prevent future crises. A crucial component of FIRREA was its focus on regulating real estate appraisals in federally related transactions. This meant appraisals used in connection with loans, mortgages, or other financial transactions involving federal agencies or institutions.

C. Key Provisions of FIRREA Related to Appraisals

FIRREA established the following key requirements:

1. State Certification and Licensing: FIRREA mandated that states establish systems for certifying and licensing real estate appraisers. This ensured that only qualified individuals could perform appraisals for federally related transactions.
2. The Appraisal Subcommittee (ASC): FIRREA created the Appraisal Subcommittee (ASC), a federal body responsible for overseeing state appraiser regulatory programs and monitoring the activities of the Appraisal Foundation.
3. Uniform Standards of Professional Appraisal Practice (USPAP) Recognition: FIRREA implicitly recognized the importance of standardized appraisal practices. The USPAP, developed by the appraisal profession, became the benchmark for appraisal methodology and reporting.

III. The Appraisal Foundation: A Cornerstone of Professionalism

A. Formation and Purpose

Prior to FIRREA, appraisal standards were largely self-regulated within professional organizations. In 1987, recognizing the need for a more unified and robust approach, nine professional appraisal associations joined together to form the Uniform Standards of Professional Appraisal Practice (USPAP). The nine associations were the American Institute of Real Estate Appraisers, the American Society of Appraisers, the American Society of Farm Managers and Rural Appraisers, the Appraisal Institute of Canada, the International Association of Assessing Officers, the International Right-of-Way Association, the National Association of Independent Fee Appraisers, the National Society of Real Estate Appraisers, and the Society of Real Estate Appraisers. The year 1987 also saw the birth of the APPRAISAL FOUNDATION, a non-profit corporation based in Washington, D.C., that was created by the same professional associations that made up the Ad Hoc Committee (with the exception of the Appraisal Institute of Canada). According to the bylaws of the Appraisal Foundation, its purpose is “to foster professionalism by helping to ensure that appraisers are qualified to offer their services and by promoting the Uniform Standards of Professional Appraisal Practice.”

B. Key Boards within the Appraisal Foundation

The Appraisal Foundation operates through several key boards, each with a distinct function:

1. Appraisal Standards Board (ASB): The ASB is responsible for developing, interpreting, and revising USPAP. They ensure that USPAP remains relevant and reflects current appraisal practices and legal requirements. The ASB actively solicits feedback from appraisers, users of appraisal services, and other stakeholders to ensure that USPAP remains a practical and effective framework.
2. Appraiser Qualifications Board (AQB): The AQB establishes minimum education, experience, and examination requirements for appraiser licensing and certification. They promote consistent qualification standards across different states. College education requirements are a fundamental component of these changes. Applicants for a Residential license are required to have a minimum of 30 college semester units or an Associate’s degree; whereas applicants for either a Certified Residential or a Certified General license are required to have a Bachelor’s degree or higher. These requirements became effective for individuals seeking a real property appraiser credential after January 1, 2015. The requirements also apply to existing real property appraisers seeking to upgrade a license. Appraisers wishing to upgrade their license will have to meet the new criteria.
3. Appraisal Practices Board: The Appraisal Practices Board serves to codify and implement the best practices and application for appraisers.

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

USPAP is the cornerstone of appraisal professionalism. It provides a comprehensive framework for:

1. Ethical Conduct: USPAP emphasizes integrity, objectivity, and impartiality. Appraisers must avoid conflicts of interest and ensure that their opinions are unbiased. The Conduct section requires the appraiser to take all necessary steps to avoid behavior that might be misleading or fraudulent. The Management section concerns the ethics of appraisal business practices, particularly compensation arrangements and advertising. Practices specifically identified as unethical include contingent compensation arrangements, undisclosed procurement payments, and false or misleading advertising. The third section of the Ethics Rule, the Confidentiality section, requires the appraiser to protect the confidentiality of information obtained from a client or results produced for a client. Disclosure of such information is limited to the client, to persons authorized by the client or by law, and to members of an authorized peer review committee. The final section of the Ethics Rule is the Record Keeping section. This section sets out the record keeping requirements for all written or oral appraisals, including the types of records that must be kept, and the length of time that the records must be maintained.
2. Competency: Appraisers must possess the necessary knowledge and experience to perform assignments competently. If an appraiser lacks competence in a particular area, they must disclose this to the client and take steps to acquire the necessary expertise or associate with a qualified appraiser.
3. Scope of Work: USPAP emphasizes the importance of defining the scope of work appropriately. This includes identifying the problem to be solved, determining the necessary data and analyses, and communicating the findings clearly and accurately. The appraiser determines the amount of work and type of report required, NOT the client. The appraiser is the professional and has a responsibility to ensure that the report will not be misunderstood or be misleading in the market❓place. In other words, the client may not be the only user or reader of the report. The fact that a client wants something less than a complete report is not sufficient reason in itself to provide one. The appraiser has a professional responsibility to provide clients with what they actually “need,” rather that what they may “want.”
4. Reporting Standards: USPAP sets forth specific requirements for appraisal reports, including the level of detail required, the types of analyses to be performed, and the format for presenting the findings.

USPAP consists of:

• an introductory section on general ethical rules,
• ten Standards, with associated Standards Rules, and
• clarifying Statements on Appraisal Standards. In addition, the Appraisal Standards Board (ASB) has issued a number of Advisory Opinions, which give advice from the ASB on the application of the Standards to specific appraisal situations.

D. USPAP Standards

There are 10 Standards in the USPAP, as shown in Figure 14-7. Each Standard consists of a generalized Statement (the standard itself) followed by more detailed and specific Standards Rules.

Figure 14-7
USPAP Standards
Standard 1 - Real Property Appraisal, Development
Standard 2 - Real Property Appraisal, Reporting
Standard 3 - Appraisal Review, Development, and Reporting
Standard 4 - Real Property Appraisal Consulting, Development (Retired in 2016) Standard 5 - Real Property Appraisal Consulting, Reporting (Retired in 2016) Standard 6 - Mass Appraisal, Development, and Reporting
Standard 7 - Personal Property Appraisal, Development Standard 8 - Personal Property Appraisal, Reporting Standard 9 - Business Appraisal, Development Standard 10 - Business Appraisal Reporting

E. INTRODUCTORY PROVISIONS OF THE USPAP
The introductory provisions of the USPAP are general rules that apply to all types of appraisals. There are seven introductory provisions:

1. Preamble,
2. Ethics Rule,
3. Competency Rule,
4. Scope of Work,
5. Jurisdictional Exception Rule,
6. Definitions, and
7. Glossary (Removed).

The Standards include Statements on Appraisal Standards issued by the Appraisal Standards Board. Explanatory comments are an integral part of the Uniform Standards and should be viewed as extensions of the document.

IV. State Licensing and Certification

A. Variations in State Requirements

While FIRREA established the requirement for state licensing and certification, the specific criteria vary from state to state. The licensing/certification laws and regulations of each state must meet minimum standards set by federal law, but the states are free to impose their own stricter standards as well. This is true both with respect to the standards of competence required for licensing or certification, and also with respect to the circumstances under which a license or certification is required.

B. Levels of Licensure and Certification

In most states, there are two primary levels of certification:

1. Residential Certification: Allows appraisers to appraise residential properties, typically defined as one-to-four unit dwellings. RESIDENTIAL CERTIFICATION is the more limited of the two; as its name suggests, it qualifies the appraiser with respect to residential properties only.
2. General Certification: Allows appraisers to appraise all types of real property, including residential, commercial, industrial, and agricultural properties. GENERAL CERTIFICATION places more emphasis on the income approach, and qualifies the appraiser for all types of properties.

C. Basic Education Module and Subtopics

The following are the subtopics for each module (see Figure 14-4 and Figure 14-5). Not all module subtopics are required for credit toward completion of a module. The examination, however, is based on all of the subtopics. Courses may contain one module or parts of one or more modules.

Figure 14-4
BASIC APPRAISAL PRINCIPLES
(30 hours required at all Levels)
A Real Property Concepts & Characteristics
B Legal Considerations
C Influences on Real Estate Values - Environmental, Geographic, & Physical
D Types of Value
E Ethics and How They Apply in Appraisal Theory and Practice
F Economic Principles
G Overview of Real Estate Markets and Analysis - Market Fundamentals, Characteristics, and Definitions

BASIC APPRAISAL PROCEDURES
(30 hours required at all Levels)
A Overview to Approaches to Value
B Valuation Procedures
C Property Description Construction
D Residential Applications
15-HOUR NATIONAL USPAP COURSE
or it’s equivalent (required at all Levels)

RESIDENTIAL MARKET ANALYSIS & HIGHEST AND BEST USE
(15 hours required at AT, AL, & AR Levels)
A Residential Markets and Analysis - Market Fundamentals, Charcteristics, & Definitions
B Highest and Best Use

RESIDENTIAL SITE VALUATION & COST APPROACH
(15 hours required at AT, AL, & AR Levels)
A Site Valuation
B Cost Approach

RESIDENTIAL SALES COMPARISON & INCOME APPROACHS
(30 hours required at AT, AL, & AR Levels)
A Valuation Principles & Procedures - Sales Comparison Approach
B Valuation Principles & Procedures - Income Approach
C Finance & Cash Equivalency
D Financial Calculator Introduction
E Identification, Derivation, & Measurement of Adjustments
F Gross Rent Multipliers
G Partial Interests
H Reconciliation
I Case Studies & Applications

RESIDENTIAL REPORT WRITING & CASE STUDIES
(15 hours required at AT, AL, & AR Levels)
A Writing & Reasoning Skills
B Common Writing Problems
C Form Reports
D Report Options and USPAP Compliance
E Case Studies

STATISTICS, MODELING, & FINANCE
(15 hours required at AT, AL, & AR Levels)
A Statistics
B Valuation Models (AVM’s & Mass Appraisal)
C Real Estate Finance

ADVANCED RESIDENTIAL APPLICATIONS & CASE STUDIES
(15 hours required at AR Level)
A Complex Property, Ownership, & Market Conditions
B Deriving & Supporting Adjustments
C Residential Market Analysis
D Advanced Case Studies

GENERAL APPRAISER MARKET ANALYSIS & HIGHEST & BEST USE
(30 hours required at AG Level)
A Residential Market Analysis - Market Fundamentals, Charcteristics, & Definitions
B Highest & Best Use

GENERAL APPRAISER SALES COMPARISON APPROACH
(30 hours required at AG Level)
A Value Principles
B Procedures
C Reconciliation
D Identification & Measurement of Adjustments
E Case Studies

GENERAL APPRAISER SITE VALUATION & COST APPROACH
(30 hours required at AG Level)
A Site Valuation
B Cost Approach

GENERAL APPRAISER INCOME APPROACH
(60 hours required at AG Level)
A Overview
B Compound Interest
C Lease Analysis
D Income Analysis
E Vacancy and Collection Loss
F Estimating Operating Expenses & Reserves
G Reconstructed Income & Expense Statement
H Stabilized Net Operating and Expense Statement
I Direct Capitalization
J Discounted Cash Flow
K Yield Capitalization
L Partial Interests
M Case Studies

GENERAL APPRAISER REPORT WRITING & CASE STUDIES
(30 hours required at AG Level)
A Writing & Reasoning Skills
B Common Writing Problems
C Report Options & USPAP Compliance
D Case Studies

Figure 14-5
BASIC EDUCATION MODULE REQUIREMENTS
Minimum
Hours
License Level
Basic Education Modules
Trainee & Residential
Certified
Residential
Certified
General
30 Basic Appraisal Principles X X X
30 Basic Appraisal Procedures X X X
15 15-Hour National USPAP Course X X X
15 Residential Market Analysis & Highest and Best Use X X
15 Residential Appraiser Site Valuation & Cost Approach X X
30 Residential Sales Comparison & Income Approach X X
15 Residential Report Writing & Case Studies X X
15 Advanced Residential Applications & Case Studies X
15 Statistics Modeling & Finance X X
30 General Appraiser Market Analysis & Highest and Best Use X
30 General Appraiser Sales Comparison Approach X
30 General Appraiser Site Valuation & Cost Approach X
30 General Appraiser Report Writing & Case Studies X
60 General Appraiser Income Approach X
Appraisal Subject Matter Electives. May include hours over the minimum requirement in the above modules or in modules not required
20
Hours
30
Hours

V. Professionalism in Practice

A. Ethical Considerations

Beyond USPAP, true professionalism involves a commitment to ethical conduct in all aspects of appraisal practice. This includes:

1. Independence and Objectivity: Maintaining independence from undue influence and providing unbiased opinions.
2. Confidentiality: Protecting the confidentiality of client information.
3. Competence: Accepting assignments only when qualified and seeking assistance when necessary.
4. Integrity: Acting with honesty and transparency in all dealings.

B. Continuous Professional Development

The real estate market is constantly evolving, requiring appraisers to engage in continuous professional development. This can include:

1. USPAP Updates: Staying current with the latest changes to USPAP.
2. Continuing Education: Taking courses and attending seminars to expand knowledge and skills.
3. Market Analysis: Monitoring market trends and data to ensure accurate valuations.
4. Technology Adoption: Utilizing new technologies and software to improve efficiency and accuracy.

C. Appraisal Management Companies (AMCs)

When a consumer is purchasing a home, their lending institution will require an appraisal of the house in order to obtain an updated value of the property to be mortgaged. Federal guidelines now require banks to have a “firewall” between lenders and appraisers. Appraisal management companies have existed for decades, but for the first time their role of adding a buffer between lender and appraisers is now a legally required part of the mortgage process. These appraisal management companies help consumers obtain unbiased reports for financing and loan servicing.

In order to provide appraisals, an APPRAISAL MANAGEMENT COMPANY (AMC) maintains a pool of qualified appraisers. When appraisal requests come in from the lending institution, the AMC assigns an appraiser to provide an appraisal report for the property. The appraiser does not receive any prior indication of the property value and may not have direct communication with the lending institution (firewall). The appraiser will provide an appraisal report based on the Uniform Standards of Professional Appraisal Practice (USPAP) guidelines Appraisal Practice (USPAP) guidelines.

VI. Case Studies and Practical Applications

A. Case Study 1: Identifying and Mitigating Conflicts of Interest

• Scenario: An appraiser is asked to appraise a property owned by a close friend.
• Analysis: USPAP requires disclosure of any potential conflicts of interest. In this case, the appraiser should disclose the relationship to the client and determine whether it compromises their objectivity.
• Solution: If objectivity cannot be assured, the appraiser should decline the assignment or associate with another qualified appraiser to provide an independent opinion.

B. Case Study 2: Applying the Scope of Work Rule

• Scenario: A client requests a “drive-by” appraisal with limited data collection to minimize costs.
• Analysis: The appraiser must determine whether the limited scope of work will allow them to develop a credible appraisal. If not, they must explain the limitations to the client and propose a more appropriate scope of work.
• Solution: The appraiser might explain that a full inspection and data analysis are necessary to develop a reliable opinion of value, even if it costs more.

VII. Mathematical Formulas and Equations in Appraisal (Examples)

While this section focuses on regulations and professionalism, understanding the mathematical underpinnings of appraisal is crucial. Here are a few examples:

A. Gross Rent Multiplier (GRM)

The Gross Rent Multiplier (GRM) is used in the income approach to value.

• Formula: GRM = Sale Price / Gross Annual Rent
• Application: If a comparable property sold for $500,000andgenerated$50,000 in gross annual rent, the GRM is 10. This GRM can then be applied to the gross annual rent of the subject property to estimate its value.

B. Capitalization Rate (Cap Rate)

The capitalization rate is a key component of the direct capitalization method in the income approach.

• Formula: Cap Rate = Net Operating Income (NOI) / Property Value
• Rearranged Formula to Estimate Value Value = NOI / Cap Rate
• Application: If a property has a Net Operating Income (NOI) of $75,000andthemarketcapitalizationrateforsimilarpropertiesis8$937,500.

C. Cost Approach: Replacement Cost Calculation

• Formula: Value = Cost of New - Depreciation + Land Value
• Application:
  • Cost to build a new house = 500,000
  • Depreciation = 50,000
  • Land Value = 250,000
  • Value = 500,000 - 50,000 + 250,000 = 700,000

VIII. Conclusion

FIRREA and the development of appraisal standards have profoundly shaped the appraisal profession. By mandating licensing and certification, establishing USPAP, and creating oversight bodies like the ASC and the Appraisal Foundation, FIRREA has fostered greater professionalism, accountability, and public trust. Appraisers must remain committed to ethical conduct, continuous learning, and adherence to USPAP to ensure the integrity and reliability of their opinions. This, in turn, contributes to the stability and transparency of the real estate market.