Foundations of Ethical Appraisal: USPAP Structure and Key Elements

Chapter: Foundations of Ethical Appraisal: USPAP Structure and Key Elements

I. Introduction: The Imperative of Ethical Appraisal

Ethical appraisal practices are foundational to maintaining public trust in financial markets and ensuring sound economic decision-making. The Uniform Standards of Professional Appraisal Practice (USPAP) provides the ethical and performance framework for appraisers. This chapter explores the structure and key elements of USPAP, providing a scientific understanding of its principles and their practical application.

II. The Genesis of USPAP and the Appraisal Foundation

A. Pre-USPAP Landscape: A Lack of Standardization

Prior to the 1980s, the appraisal profession operated with limited oversight. This lack of standardization and regulatory control led to inconsistencies and, in some instances, unethical practices that contributed to the Savings and Loan (S&L) crisis.

B. The S&L Crisis and the Call for Reform

The collapse of the S&L industry highlighted the critical need for appraisal reform. Questionable appraisal practices were identified as a contributing factor to the crisis. This led to a concerted effort to establish industry-wide standards for competence and professional conduct.

C. Birth of the Appraisal Foundation and USPAP

• 1985: Nine appraisal professional organizations joined forces to create the Ad Hoc Committee on Uniform Standards of Professional Appraisal Practice (USPAP).
• 1987: The Ad Hoc Committee released the first version of USPAP. This same year, the APPRAISAL FOUNDATION was established as a non-profit organization. The Appraisal Institute of Canada was part of the Ad Hoc Committee but did not join The Appraisal Foundation.
• Mission of the Appraisal Foundation: The Appraisal Foundation’s 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.”
• 1989: USPAP was incorporated into law through the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), commonly known as “the S&L bail-out bill.” FIRREA mandated state certification and licensing of appraisers based on recognized standards of competence.

D. The Appraisal Foundation’s Structure

The Appraisal Foundation oversees the development, interpretation, and promotion of USPAP through its independent boards.

1. Appraisal Standards Board (ASB):

   • Responsible for developing, interpreting, and revising USPAP.
   • Promotes the acceptance and use of USPAP.

2. Appraiser Qualifications Board (AQB):

   • Establishes minimum education, experience, and examination requirements for appraiser licensure and certification.

3. Appraisal Practices Board (APB):

   • Identifies and promotes best practices in appraisal.
   • Provides guidance on complex appraisal issues.

III. USPAP Structure and Key Elements: A Scientific Examination

USPAP is a complex and evolving document, designed to provide a robust framework for ethical and competent appraisal practice.

A. Overall Structure

USPAP comprises the following key components:

1. Preamble: Sets forth the purpose and scope of USPAP.
2. ethics rule❓❓: Establishes ethical obligations for appraisers, including conduct, management, confidentiality, and record keeping.
3. Competency Rule: Requires appraisers to be competent to perform the appraisal service or to acquire the necessary competency.
4. Scope of Work Rule: Defines the appraiser’s responsibilities for determining the appropriate scope of work for an appraisal assignment.
5. Jurisdictional Exception Rule: Allows for deviation from USPAP when required by law or regulation.
6. Definitions: Defines terms used throughout USPAP.
7. Standards: Ten (10) specific standards addressing various aspects of appraisal practice.
8. Standards Rules: Specific requirements within each Standard that must be followed.
9. Statements on Appraisal Standards (SMT): Clarify, interpret, explain, or elaborate on existing Standards or Standards Rules. These have the same binding effect as the Standards themselves.
10. Advisory Opinions (AO): Offer advice from the ASB on applying USPAP to specific situations. These are not binding.

B. Key Elements: A Deep Dive

Let’s examine some of the most critical elements in detail:

1. Ethics Rule:

   • Conduct: An appraiser must act with integrity, impartiality, and objectivity. They must not engage in conduct that is misleading or fraudulent.
   • Management: Appraisal businesses must be managed ethically. Contingent fees are generally prohibited, meaning fees cannot be tied to a predetermined value conclusion. Advertising must be truthful and not misleading.

   Ethical Considerations and Statistical Bias: An appraiser must be careful about introducing bias into their appraisal. This may be done consciously, but it is also possible to be done through cognitive bias or insufficient data collection.
   For example, suppose an appraiser uses data available only in affluent neighborhoods. This could result in positive bias in the model. To mitigate this, the appraiser must make efforts to include datasets that account for socio-economic diversity in the model or make proper reconciliation/adjustments.
   * Confidentiality: Appraisers must protect the confidentiality of client information and appraisal results. Disclosure is permitted only to the client, those authorized by the client, or when required by law.

   Mathematical Formulation of Confidentiality Risk: One could frame the risk of breaching confidentiality in terms of information theory. Let I(X;Y) be the mutual information between the client’s confidential information X and the appraiser’s actions Y. The goal is to minimize I(X;Y) while still providing a credible appraisal.
   Minimize: I(X;Y) = Σ Σ p(x,y) log (p(x,y) / (p(x)p(y)))
   where p(x,y) is the joint probability distribution of X and Y, and p(x) and p(y) are the marginal probability distributions.

   • Record Keeping: Appraisers must maintain work files that support their appraisal opinions. These files must be retained for at least five years after completion of the assignment, or at least two years after final disposition of any judicial proceeding in which the appraiser provided testimony.
     2. Competency Rule:

   • Appraisers must possess the necessary knowledge and experience to perform an appraisal assignment competently. This includes understanding:

     • The specific type of property being appraised.
     • The applicable market area.
     • The relevant valuation methods and techniques.
     • Applicable laws and regulations.
   • If an appraiser lacks the necessary competency, they must:
     • Disclose the lack of competency to the client before accepting the assignment.
     • Take all necessary steps to achieve competency, such as consulting with an experienced appraiser or completing additional training.
     • Disclose the steps taken to achieve competency in the appraisal report.
   • The “Scope of Work Rule” applies as well, requiring the appraiser to develop a plan to perform the services competently.

   Competency and Bayesian Inference: We can think of competency as a prior belief about an appraiser’s ability to accurately estimate value. Bayesian inference can be used to update this belief as the appraiser gains experience and receives feedback.

   ```
   P(Competent | Data) = [P(Data | Competent) * P(Competent)] / P(Data)
   ```
   
   Where:
   *   *P(Competent | Data)* is the posterior probability of being competent given the data.
   *   *P(Data | Competent)* is the likelihood of observing the data (e.g., appraisal accuracy) given the appraiser is competent.
   *   *P(Competent)* is the prior probability of the appraiser being competent.
   *   *P(Data)* is the probability of observing the data.
   

2. Scope of Work Rule:

   • The scope of work encompasses the extent of research and analysis performed in an appraisal assignment. It includes:

     • Identifying the problem to be solved (the appraisal assignment).
     • Determining the appropriate scope of work to produce credible assignment results.
     • Disclosing the scope of work in the appraisal report.

   • The scope of work must be sufficient to produce credible assignment results. Factors to consider include:

     • The intended use of the appraisal.
     • The complexity of the property.
     • The availability of data.
     • The client’s expectations.
     • The expectations of intended users.

   • An appraiser cannot allow the client’s desired value conclusion to influence the scope of work. The appraiser determines the scope of work based on what is necessary to produce a credible appraisal.
     Statistical Analysis in Scope of Work: In many cases, statistical analysis is crucial to setting an appropriate scope of work. For example, analyzing the variance in comparable sales data (σ²) helps determine the necessary number of comparable sales to achieve a desired level of confidence (1 - α) in the value estimate. We can use the sample size formula for estimating a population mean:

     n = (z<sub>α/2</sub> * σ / E)<sup>2</sup>

     Where:
     * n is the required sample size (number of comparables).
     * z_α/2 is the z-score corresponding to the desired confidence level (e.g., 1.96 for 95% confidence).
     * σ is the estimated standard deviation of comparable sales prices.
     * E is the desired margin of error.
     4. Jurisdictional Exception Rule:

   • This rule allows for deviation from USPAP when a specific law or regulation in a particular jurisdiction conflicts with USPAP.

   • The appraiser must:
     • Identify the specific law or regulation that conflicts with USPAP.
     • Comply with the law or regulation.
     • Disclose the jurisdictional exception in the appraisal report.
   • The Jurisdictional Exception Rule only applies when compliance with USPAP would violate a law or regulation, not simply when it is inconvenient or less profitable.

3. Definitions:
   * Each term in USPAP has a specific meaning. The appraiser must be familiar with these definitions to ensure a credible valuation.

4. Standards:
   * USPAP presents 10 standards of professional practice.

   • Standard 1: Real Property Appraisal, Development. Focuses on the process of developing a real property appraisal.
   • Standard 2: Real Property Appraisal, Reporting. Addresses the requirements for communicating the results of a real property appraisal.
   • Standard 3: Appraisal Review, Development and Reporting. Covers the review of another appraiser’s work.
   • Standard 6: Mass Appraisal, Development, and Reporting. Pertains to the development and reporting of mass appraisals, often used for property tax purposes.
   • Standard 7 & 8: Personal Property Appraisal, Development and Reporting. Focuses on developing and reporting personal property appraisals.
   • Standard 9 & 10: Business Appraisal, Development and Reporting. Development and reporting of business appraisals.

C. Practical Applications and Experiments

1. Ethics Experiment: Conduct a thought experiment involving a potential contingent fee arrangement. Ask participants to analyze the ethical implications and potential biases that could arise. Discuss how the Ethics Rule addresses such situations.

2. Competency Case Study: Present a scenario where an appraiser is asked to appraise a complex industrial property with which they have no prior experience. Have participants identify the steps the appraiser should take to comply with the Competency Rule.

3. Scope of Work Simulation: Provide a hypothetical appraisal assignment with varying levels of available data. Challenge participants to develop different scopes of work based on the intended use of the appraisal and the data limitations.

4. Jurisdictional Exception Example: Research a real-world example where a jurisdictional exception was invoked. Analyze the circumstances that led to the exception and the appraiser’s obligations under USPAP. For example, research how eminent domain laws influence jurisdictional exception and its implications for property valuation, particularly regarding fair compensation.

IV. The Role of Appraisal Management Companies (AMCs)

• Firewall Implementation: FIRREA mandates a firewall between lenders and appraisers to ensure objectivity and prevent undue influence.
• AMC Responsibilities: AMCs facilitate this firewall by:
  • Maintaining a pool of qualified appraisers.
  • Assigning appraisers to appraisal requests from lending institutions.
  • Ensuring appraisers operate independently and without prior knowledge of the desired property value.

V. Navigating the Evolving Landscape: USPAP Updates and Resources

• Annual Updates: USPAP is a living document, updated annually by the ASB to reflect changes in appraisal practice and market conditions. Appraisers must stay current with the latest revisions.
• Key Resources:
  • The Appraisal Foundation: www.appraisalfoundation.org
  • State Appraisal Regulatory Agencies
  • Professional Appraisal Organizations (e.g., ASA, AI)

VI. Conclusion: Upholding the Integrity of the Appraisal Profession

A thorough understanding of USPAP is essential for all appraisers. By adhering to the ethical and performance standards outlined in USPAP, appraisers uphold the integrity of the profession, protect the public trust, and contribute to sound financial markets. Continuous professional development and engagement with the Appraisal Foundation are critical for staying informed and maintaining competency in this dynamic field.