USPAP: Ethics, Competency, and the Appraisal Foundation

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Chapter Title: USPAP: Ethics, Competency, and the Appraisal Foundation

I. Introduction: The Evolution of Appraisal Standards

Prior to the 1980s, the appraisal industry lacked consistent, legally enforceable standards. This absence of rigorous oversight contributed to financial instability, particularly during the Savings and Loan (S&L) crisis. This period highlighted the critical need for standardized appraisal practices to ensure accuracy, objectivity, and ethical conduct within the profession. The current framework is rooted in a multi-faceted response, bringing together industry self-regulation, federal legislation, and state-level enforcement.

• Historical Context: The S&L crisis revealed that inadequate appraisal practices could lead to inflated property values, contributing to risky lending and financial instability. The lack of uniform standards made it difficult to identify and address these problematic appraisals.

• The Need for Uniformity: The response to the S&L crisis included establishing a uniform set of standards, aimed at enhancing the credibility and reliability of appraisals used in financial transactions. This led to the formation of The Appraisal Foundation and the development of USPAP.

II. The Appraisal Foundation: A Scientific Analysis of its Structure and Function

The Appraisal Foundation (TAF) is a private, non-profit organization tasked with promoting professionalism and establishing appraisal standards and appraiser qualifications. Its structure comprises several key boards, each with specific responsibilities that contribute to the overall governance and integrity of the appraisal profession.

• Formation: Nine professional appraisal organizations initially formed the Ad Hoc Committee on Uniform Standards of Professional Appraisal Practice (USPAP). This committee evolved into The Appraisal Foundation.
• Mission: The Appraisal Foundation’s core mission is to promote professionalism by ensuring that appraisers are qualified and that the Uniform Standards of Professional Appraisal Practice (USPAP) are effectively implemented.

• Organizational Structure:

  1. Appraisal Standards Board (ASB):
     • Function: The ASB is responsible for developing, interpreting, and revising USPAP.
     • Standard Development: The ASB operates through a rigorous process involving exposure drafts, public comment periods, and careful consideration of industry needs and best practices.
     • Theoretical Basis: The ASB’s activities are grounded in principles of standardization and quality assurance. Standardization reduces variability and increases predictability in appraisal outcomes, which is essential for risk management in financial markets. Quality assurance ensures that appraisals are reliable and meet established criteria.
  2. Appraiser Qualifications Board (AQB):
     • Function: The AQB establishes minimum education, experience, and examination requirements for appraiser licensing and certification.
     • Competency Framework: The AQB’s requirements are designed to ensure that appraisers possess the necessary knowledge and skills to perform competent appraisals.

     • Mathematical Representation: The impact of the AQB’s standards on appraiser competency can be conceptualized using a hypothetical model. Let:

       • C = Overall appraiser competency
       • E = Education level (measured in hours of coursework)
       • X = Experience (measured in hours of practical appraisal work)
       • T = Testing score (standardized score on a licensing exam)
       • k1, k2, k3 = Weights reflecting the relative importance of each factor

       Then, a simplified competency model could be:

       C = k1*E + k2*X + k3*T

       The AQB influences E, X, and T through its standards. The model illustrates how these factors combine to determine overall competency.
       3. Appraisal Practices Board (APB):
       * Function: The APB identifies and promotes best practices in the appraisal profession.
       * Best Practices: The APB codifies best practices that promote credible appraisal results.
       4. Board of Trustees (BOT)
       * Function: responsible for the overall governance, strategic planning, and financial oversight of The Appraisal Foundation.
       * Sponsorship: TAF’s sponsors include organizations like the American Society of Appraisers (ASA), the American Society of Farm Managers and Rural Appraisers (ASFMRA), and the National Association of REALTORS®. These organizations provide financial support and industry expertise, helping TAF fulfill its mission.

III. FIRREA: Federal Mandate and Regulatory Impact

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was a landmark piece of legislation that significantly reshaped the appraisal industry. It mandated state licensing and certification of appraisers involved in federally related transactions, thereby integrating USPAP into law.

• Key Provisions: FIRREA required states to implement appraiser licensing and certification programs that meet minimum standards set by the federal government. These standards are largely based on the AQB’s recommendations.

• Federally Related Transactions: FIRREA applies to appraisals performed in connection with any real estate-related financial transaction in which a federal financial institution or regulatory agency has a direct or indirect interest. This includes mortgage lending, loan servicing, and property sales involving banks, credit unions, and other federally regulated entities.

• Impact Analysis: FIRREA created a demand for qualified appraisers, increased the overall competency of the profession, and reduced the incidence of fraudulent or misleading appraisals in federally related transactions.

  • Before FIRREA: There was limited government regulation of appraisers, and standards varied widely.
  • After FIRREA: Appraisers must meet specific education, experience, and testing requirements. They are also subject to disciplinary action for violations of USPAP.

  • Mathematical Modeling (Impact Assessment):

  • Hypothesis: FIRREA and the implementation of USPAP have reduced the error rate in appraisals used for mortgage lending.

  • Data Collection: Collect data on the rate of appraisal errors (e.g., significant overvaluations or undervaluations) before and after FIRREA.

  • Statistical Analysis: Use a t-test to compare the means of the error rates before and after FIRREA.

    • Null Hypothesis (H0): The mean error rate before FIRREA is equal to the mean error rate after FIRREA.
    • Alternative Hypothesis (H1): The mean error rate before FIRREA is greater than the mean error rate after FIRREA.

    Formula:

    • t = (μ1 - μ2) / √(s1^2/n1 + s2^2/n2)

      • Where:
        • μ1 = Mean error rate before FIRREA
        • μ2 = Mean error rate after FIRREA
        • s1 = Standard deviation of error rate before FIRREA
        • s2 = Standard deviation of error rate after FIRREA
        • n1 = Sample size before FIRREA
        • n2 = Sample size after FIRREA

  • Interpretation: If the t-statistic is significant (p-value < 0.05), it would provide statistical evidence supporting the hypothesis that FIRREA has reduced appraisal errors.

IV. USPAP: Ethics Rule

The Ethics Rule within USPAP is foundational to maintaining public trust in the appraisal profession. It comprises several key elements:

• Conduct: Appraisers must perform assignments with impartiality, objectivity, and independence. They must not engage in conduct that is biased or misleading.
  • Example: An appraiser must not accept an assignment if they have a personal or financial interest in the property being appraised.
• Management: Appraisal business practices must be ethical and transparent. This includes avoiding contingent fees that could compromise objectivity, disclosing any procurement payments, and ensuring that advertising is truthful and not misleading.
  • Contingent Fees: A contingent fee arrangement where the appraiser’s fee is dependent on the value conclusion is unethical. Such arrangements create a conflict of interest and can incentivize appraisers to inflate values.
• Confidentiality: Appraisers must protect the confidentiality of client information and appraisal results. Disclosure is only permitted with the client’s consent, as required by law, or to authorized peer review committees.
  • Legal Obligations: The confidentiality rule does not override legal obligations. Appraisers may be required to disclose information in response to a subpoena or other legal order.
• Record Keeping: Appraisers must maintain accurate and complete records of each appraisal assignment, including work files, data, and reports. These records must be retained for a minimum period (typically five years after preparation or two years after final disposition of judicial proceedings).
  • Quality Assurance: Record keeping supports quality assurance and facilitates review by peers, regulators, or legal authorities.

V. USPAP: Competency Rule

The Competency Rule is a critical safeguard against incompetent appraisal practice.

• Core Principle: An appraiser must have the knowledge and experience necessary to perform an appraisal assignment competently. If an appraiser lacks the necessary competency, they must either decline the assignment or take steps to achieve competency before accepting it.
• Achieving Competency:
  1. Disclose the Lack of Competency: The appraiser must inform the client of their lack of competency.
  2. Take Necessary Steps: The appraiser must take all steps necessary to complete the assignment competently. This may include:
     • Consulting with qualified experts
     • Conducting additional research
     • Obtaining specialized education or training
  3. Disclose Assistance: The appraiser must disclose the assistance of any expert in the report.
• Application in Practice:
  • Example 1: An appraiser specializing in residential properties is asked to appraise a complex industrial facility. The appraiser must disclose their lack of expertise and either decline the assignment or associate with an appraiser who has the necessary experience and expertise.
  • Example 2: An appraiser lacking experience in valuing conservation easements is asked to appraise a property with a conservation easement. The appraiser must research the specific legal and economic aspects of conservation easements and consult with experts in this area to ensure a competent appraisal.

VI. USPAP: Scope of Work Rule

The Scope of Work Rule provides appraisers with flexibility in determining the extent of research and analysis required for an appraisal assignment.

• Key Components: The scope of work must include:
  1. Identifying the Problem: Defining the appraisal problem, including the intended use of the appraisal, the type of value being sought, and the property characteristics.
  2. Determining the Scope of Work: Deciding on the extent of research and analysis necessary to produce credible results.
  3. Disclosing the Scope of Work: Clearly describing the scope of work in the appraisal report.

• Credibility: The scope of work must be sufficient to produce credible appraisal results that are appropriate for the intended use.

  Credibility Formula:

  Credibility = f(Reliability, Relevance)

  Where:

  • Reliability = extent to which appraisal data & methods consistently produce same results
  • Relevance = extent to which the data/methods are appropriate to the assignment.
  • Factors Influencing Scope of Work:
  • Intended Use: The intended use of the appraisal will influence the scope of work. A mortgage appraisal may require a different scope of work than an appraisal for estate tax purposes.
  • Property Type: The complexity of the property will influence the scope of work. A simple residential property will typically require a less extensive scope of work than a complex commercial property.
  • Data Availability: The availability of data will influence the scope of work. If reliable data is scarce, the appraiser may need to conduct additional research or use alternative methods.
    VII. USPAP: Jurisdictional Exception Rule

The Jurisdictional Exception Rule acknowledges that local laws or regulations may, in some cases, conflict with USPAP.

• Core Principle: If a specific law or regulation prevents an appraiser from complying with a specific part of USPAP, the appraiser must comply with the law or regulation. However, the appraiser must disclose the jurisdictional exception in the appraisal report.
• Limitations: The Jurisdictional Exception Rule does not allow appraisers to disregard USPAP entirely. It only applies when there is a direct conflict between USPAP and a specific law or regulation.
• Example: A state law may require appraisers to use a specific method of valuation that is inconsistent with USPAP. In this case, the appraiser must comply with the state law and disclose the jurisdictional exception in the appraisal report.

VIII. State Licensing and Certification

Although FIRREA mandates licensing and certification, the individual states manage the process. This decentralized approach leads to variations in requirements across states.

• Levels of Certification: Most states offer residential and general appraiser certifications.
  • Residential Certification: This allows appraisers to appraise residential properties.
  • General Certification: This allows appraisers to appraise all types of properties, including residential, commercial, and industrial properties.
• Requirements: Requirements vary but typically include:
  • Education: Completion of specific appraisal courses approved by the AQB.
  • Experience: Completion of a specific number of hours of supervised appraisal work.
  • Examination: Passing a state-administered examination.
• State Regulatory Agencies: Each state has a regulatory agency responsible for licensing and overseeing appraisers. These agencies also investigate complaints and take disciplinary action against appraisers who violate USPAP or other regulations.
• Enforcement: State agencies are responsible for enforcing appraisal regulations, including USPAP. They can take disciplinary action against appraisers who violate the rules, including suspension or revocation of their licenses.

IX. The Role of Appraisal Management Companies (AMCs)

Appraisal Management Companies (AMCs) have emerged as intermediaries between lenders and appraisers.
* Functions of AMCs:

*   **Panel Management:** AMCs maintain a pool of qualified appraisers.
*   **Assignment Allocation:** AMCs assign appraisal assignments to appraisers.
*   **Quality Control:** AMCs review appraisals for compliance with USPAP and lender guidelines.

• Benefits of AMCs:

  • Independence: AMCs help to ensure that appraisers are independent from lenders, reducing the risk of undue influence.
  • Efficiency: AMCs can streamline the appraisal process, making it more efficient.

  • Concerns about AMCs:

  • Fee Pressure: Some AMCs may exert downward pressure on appraisal fees, potentially compromising the quality of appraisals.

  • Communication Barriers: The use of AMCs can sometimes create barriers to communication between lenders and appraisers.

X. Conclusion: Maintaining Integrity in Appraisal Practice

Upholding ethical and competent appraisal practices is essential for maintaining the integrity of the financial system and protecting the public interest. The Appraisal Foundation, USPAP, and state licensing regulations provide a framework for ensuring that appraisers perform their duties with objectivity, independence, and expertise. Continued vigilance and adherence to these standards are crucial for preserving the credibility of the appraisal profession.