USPAP: Ethics and Standards in Valuation

USPAP: Ethics and Standards in Valuation

This chapter delves into the ethical and procedural core of real property valuation as governed by the Uniform Standards of Professional Appraisal Practice (USPAP). USPAP provides a framework for appraisers to develop and communicate credible opinions of value, ensuring public trust and maintaining the integrity of the appraisal profession. We will examine the key elements of USPAP that directly impact valuation, exploring relevant scientific principles and providing practical applications.

I. Introduction to USPAP

A. The Appraisal Foundation and its Boards:
1. Appraisal Foundation: Chartered by Congress, the Appraisal Foundation (TAF) is the authoritative source of appraisal standards and appraiser qualifications. It oversees the Appraisal Standards Board (ASB), the Appraisal Qualifications Board (AQB), and the Appraisal Practices Board (APB).

2.  **Appraisal Standards Board (ASB):** The ASB develops, interprets, and revises USPAP. Its primary goal is to promote and maintain public trust in appraisal practice.

3.  **Appraisal Qualifications Board (AQB):** The AQB establishes minimum education, experience, and examination requirements for real property appraisers.

4.  **Appraisal Practices Board (APB):** The APB identifies and issues opinions on recognized valuation methods and techniques for voluntary appraisal guidance.

B. The Purpose of USPAP:
1. Promoting Public Trust: USPAP aims to ensure that appraisers develop and communicate opinions of value that are unbiased, credible, and reliable.

2.  **Establishing Ethical Obligations:** It sets forth ethical rules and competency standards that appraisers must adhere to.

3.  **Defining Performance Standards:** USPAP outlines the requirements for appraisal development and reporting.

C. Scope of USPAP:
1. USPAP applies to appraisers when they are obligated to comply by law or regulation, or by agreement with clients or intended users.
2. USPAP applies to appraisal practice, including appraisal, appraisal review, and appraisal consulting.
3. The terms appraisal, appraisal review, and appraisal consulting are intentionally generic and not mutually exclusive.

II. Key USPAP Rules Directly Impacting Valuation

A. Ethics Rule:
1. Impartiality, Objectivity, and Independence: Appraisers must perform assignments with impartiality, objectivity, and independence, and without accommodation of personal interests.

2.  **Confidentiality:** Appraisers must protect the confidential nature of the appraiser-client relationship.

3.  **Record Keeping:** Appraisers must prepare and maintain workfiles for each assignment. These workfiles must contain sufficient information to support the appraiser's opinions and conclusions.

4.  **Example:** An appraiser is asked by a homeowner to appraise their property with the explicit instruction to "make sure it appraises at \$500,000." Accepting this assignment would violate the Ethics Rule.

B. Competency Rule:
1. Competency Requirement: Prior to accepting an assignment, an appraiser must have the knowledge and experience to complete the assignment competently, or acquire the necessary competency through study or assistance.

2.  **Disclosure:** If an appraiser lacks the necessary competency, they must disclose this lack of knowledge to the client before accepting the assignment.

3.  **Example:** An appraiser specializing in residential properties is asked to appraise a large industrial complex. The appraiser must either decline the assignment or associate with another appraiser who has the necessary experience and competence to value such a property.

C. Scope of Work Rule:
1. Problem Identification: The appraiser must properly identify the problem to be solved, including the intended use of the appraisal, the type and definition of value, the effective date of the appraisal, and the characteristics of the property.

2.  **Scope of Work Determination:** The appraiser must determine the scope of work necessary to produce credible assignment results. This includes the extent to which the property is inspected, the data researched, and the analyses applied.

3.  **Disclosure:** The scope of work must be disclosed in the appraisal report.

4.  **Credibility:** The scope of work must be sufficient to produce credible assignment results.

5.  **Example:** For a residential appraisal intended for mortgage lending, the scope of work typically includes a physical inspection of the property, research of comparable sales data, and application of the sales comparison approach.

D. Record Keeping Rule:
1. An appraiser must prepare a workfile for each appraisal, appraisal review, or appraisal consulting assignment.
2. The workfile must include:
* The client’s identity and any other intended users.
* True copies of all reports and signed certifications.
* All other data, information, and documentation necessary to support the appraiser’s opinions and conclusions and to show compliance with USPAP.

III. Standards Rules Related to Valuation

A. Standard 1: Real Property Appraisal, Development
1. Identifying the Problem: Appraisers must accurately identify the appraisal problem, which includes the intended use of the appraisal, the type of value (e.g., market value❓, investment value), and the effective date of the appraisal.

2.  **Scope of Work:** Appraisers must develop a credible scope of work that is appropriate for the assignment, considering the intended use of the appraisal, the complexity of the property, and the available data.
3.  **Data Collection and Analysis:**

    *   **General Market Data:** This includes information on economic trends, demographics, and market conditions affecting property values.

    *   **Subject Property Data:** This includes information on the physical characteristics of the property, its legal rights, and its historical performance.
    *   **Comparable Property Data:** This includes information on sales, listings, and other relevant data for comparable properties.

4.  **Application of Valuation Methods:** Appraisers must apply appropriate valuation methods, such as the sales comparison approach, the cost approach, and the income capitalization approach.

    *   **Sales Comparison Approach:** Based on the principle of substitution, this approach estimates value by comparing the subject property to similar properties that have recently sold. Adjustments are made to the sale prices of the comparables to account for differences in location, condition, size, and other factors.

    *   **Cost Approach:** This approach estimates value by summing the estimated cost to reproduce or replace the property, less depreciation, plus the value of the land. It is based on the principle of substitution, which states that a buyer will not pay more for a property than the cost of building a new one.

    *   **Income Capitalization Approach:** This approach estimates value by capitalizing the income that the property is expected to generate. It is based on the principle of anticipation, which states that value is based on the expected future benefits of ownership.

5.  **Reconciliation:** Appraisers must reconcile the value indications from the different approaches to arrive at a final opinion of value. This involves considering the strengths and weaknesses of each approach and giving the most weight to the approach that is most reliable for the specific assignment.

B. Standard 2: Real Property Appraisal, Reporting

1.  **Clarity and Accuracy:** Appraisal reports must be clear, accurate, and adequately descriptive.

2.  **Disclosure:** All assumptions, extraordinary assumptions, and hypothetical conditions must be clearly disclosed in the report.

3.  **Content Requirements:** Appraisal reports must include specific information, such as the identity of the client, the intended use of the appraisal, the definition of value, the scope of work, and the appraiser's opinion of value.

4.  **Reporting Options:** USPAP allows for three different reporting options: *Appraisal Report*, *Summary Appraisal Report*, and *Restricted Appraisal Report*.

    *   **Appraisal Report:** This is the most comprehensive reporting option, providing a detailed summary of the data, analyses, and reasoning used to arrive at the appraiser's opinion of value. It must contain sufficient information to allow the intended users to understand the appraisal.

    *   **Summary Appraisal Report:** This is a less detailed reporting option, providing a summary of the data, analyses, and reasoning used to arrive at the appraiser's opinion of value.

    *   **Restricted Appraisal Report:** This is the least detailed reporting option, providing a minimal amount of information. This report is intended for limited use by the client.

IV. Mathematical Formulas and Equations in Valuation

A. Sales Comparison Approach:

1.  **Adjustment Calculation:**
    *   `Adjusted Sale Price = Sale Price ± Dollar Adjustment`
    *   `Percentage Adjustment = (Dollar Adjustment / Sale Price) * 100`

B. Cost Approach:

1.  **Depreciation Calculation (Straight-Line Method):**
    *   `Annual Depreciation = (Cost - Salvage Value) / Economic Life`
2.  **Value Calculation:**
    *   `Value = Reproduction Cost - Accrued Depreciation + Land Value`

C. Income Capitalization Approach:

1.  **Net Operating Income (NOI):**
    *   `NOI = Potential Gross Income - Vacancy & Collection Losses - Operating Expenses`

2.  **Capitalization Rate (R):**
    *   `R = NOI / Property Value`

3.  **Property Value (V):**
    *   `V = NOI / R`

D. Gross Rent Multiplier (GRM):
1. GRM = Sale Price / Gross Annual Rent
2. Estimated Value = GRM * Subject Property's Gross Annual Rent

E. Present Value of an Annuity:
1. PV = PMT * [(1 - (1 + r)^-n) / r]
* Where:
* PV = Present Value
* PMT = Periodic Payment
* r = Interest Rate (Discount Rate)
* n = Number of Periods

V. Practical Applications and Experiments

A. Sales Comparison Analysis Experiment:
1. Objective: To understand the impact of adjustments on the value of comparable properties.
2. Procedure: Gather data on 3-5 comparable sales. Identify key differences between the subject property and the comparables (e.g., size, location, condition). Assign dollar or percentage adjustments for each difference. Calculate the adjusted sale prices. Analyze how the adjustments impact the final value indication.

B. Cost Approach Depreciation Estimation:
1. Objective: To practice estimating depreciation using different methods.
2. Procedure: Select a property. Estimate its reproduction or replacement cost. Estimate the physical, functional, and external depreciation. Use the age-life method, observed condition method, and market extraction method to estimate total depreciation. Compare the results and discuss the strengths and weaknesses of each method.

C. Income Capitalization Scenario:
1. Objective: To understand how capitalization rates affect property values.
2. Procedure: Select a commercial property. Estimate its potential gross income, vacancy and collection losses, and operating expenses. Calculate the NOI. Research capitalization rates for similar properties in the market. Use different capitalization rates to calculate the estimated value of the property. Analyze how changes in the capitalization rate affect the final value indication.

VI. Appraisal Report and USPAP Compliance

A. Required Elements of an Appraisal Report:
1. Client and intended users
2. Intended use
3. Type and definition of value
4. Effective date of the appraisal
5. Subject property characteristics
6. Scope of work
7. Assumptions, extraordinary assumptions, and hypothetical conditions
8. Data and analyses
9. Value opinion
10. Certification

B. Certification:
1. Each appraisal report must include a signed certification that the appraiser has complied with USPAP.
2. The certification must include specific statements regarding the appraiser’s independence, objectivity, and competency.

C. Example: An appraisal report for a residential property must clearly state the definition of market value used, describe the scope of work performed, disclose any assumptions or limiting conditions, and provide a detailed analysis of the data and methods used to arrive at the appraiser’s opinion of value.

VII. USPAP Advisory Opinions and FAQs

A. Advisory Opinions:
1. The ASB issues Advisory Opinions (AOs) to provide guidance on specific appraisal issues.
2. AOs are not part of USPAP, but they provide valuable insights into the ASB’s interpretation of the standards.

B. Frequently Asked Questions (FAQs):
1. The Appraisal Foundation provides FAQs to address common questions about USPAP.
2. FAQs are not binding, but they can help appraisers understand and apply the standards.

VIII. Conclusion

Adherence to USPAP is critical for appraisers to maintain ethical conduct, demonstrate competence, and deliver credible opinions of value. Understanding and applying USPAP standards and rules is essential for ensuring public trust and maintaining the integrity of the appraisal profession. Continuous education and staying updated on the latest USPAP changes are vital for all appraisers.