Appraisal Profession and Ethics

Appraisal Profession and Ethics

This chapter explores the foundations of the appraisal profession and the ethical considerations that guide its practice. Understanding these aspects is crucial for aspiring appraisers to ensure they provide credible and reliable valuation services.

1. Evolution of the Appraisal Profession

• Pre-FIRREA Era: Prior to the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989, the appraisal industry lacked consistent regulation. State regulations were limited, leading to inconsistent standards and varying levels of competence among practitioners. Professional designations from trade associations (e.g., MAI, SRA) were the primary means of identifying qualified appraisers, but public awareness of these designations and their requirements was limited.
• The Impact of FIRREA (1989): The Savings and Loan Crisis prompted FIRREA, which mandated state licensing or certification for appraisers involved in federally related transactions (FRTs). This marked a turning point, establishing minimum qualifications and regulatory oversight.
  • Federally Related Transaction (FRT): Defined as any real estate-related financial transaction that a Federal Financial Institutions Regulatory Agency (FFIRA) engages in, contracts for, or regulates, and that requires the services of an appraiser.
• The Appraisal Foundation (TAF): FIRREA established The Appraisal Foundation (TAF) as the authority to set appraisal rules and minimum qualifications. TAF operates through two primary boards:
  • Appraiser Qualifications Board (AQB): Sets the minimum education, experience, and examination requirements for licensing and certification. The AQB establishes the exam content outline that states use to set educational goals for their programs and to guide curriculum development.
  • Appraisal Standards Board (ASB): Develops, interprets, and revises the Uniform Standards of Professional Appraisal Practice (USPAP), the ethical and performance standards for appraisers. USPAP gains legal authority through adoption by state, local, and federal agencies.
• Appraisal Subcommittee (ASC): The Appraisal Subcommittee of the Federal Financial Institutions Examination Council (FFIEC) provides governmental oversight, ensuring state appraisal programs comply with federal regulations.
• Appraisal Institute (AI): A leading professional appraisal organization formed in 1991 through the unification of the Society of Real Estate Appraisers and the American Institute of Real Estate Appraisers (AIREA). The AI offers the MAI and SRA designations.
• State Licensing and Certification: States offer various levels of appraisal licenses and certifications, including:
  • Trainee, Registered, or Associate Appraiser.
  • Licensed Residential Appraiser.
  • Certified Residential Appraiser.
  • Certified General Appraiser.

2. Appraisal Licensing and Certification

Appraisal licensing and certification requirements vary by state. Understanding these requirements is essential for aspiring appraisers.

1. Trainee, Registered, or Associate Appraiser: This entry-level classification typically involves an apprenticeship period under the supervision of a licensed or certified appraiser. The specific requirements vary by state.
2. Licensed Residential Appraiser: Limits the appraiser to appraising one- to four-unit properties with loans less than \$1 million (transaction value) in most states. They can also perform appraisals for non-federally related transactions.
3. Certified Residential Appraiser: Allows the appraiser to appraise one- to four-unit properties with no limit on transaction value in most states. They can also perform appraisals for non-federally related transactions. In some states, they may also appraise non-residential properties for non-federally related transactions.
4. Certified General Appraiser: Authorizes the appraiser to appraise all types of properties, regardless of complexity or value. This is the highest level of appraisal certification.

Note: Holding a license or certification does not guarantee competency. Appraisers must possess the necessary knowledge, skills, and experience to competently appraise specific property types and locations.

3. Ethics in Appraisal Practice

Ethical conduct is paramount in the appraisal profession. Appraisers must maintain objectivity, impartiality, and independence to ensure credible appraisal results.

• Disinterested Third Party: Appraisers, unlike advocates such as attorneys or real estate brokers, must act as disinterested third parties, treating all parties involved (client and intended users) with fairness and impartiality. This means the appraiser must not have any bias.
• USPAP Ethics Rule: The Ethics Rule within USPAP defines the ethical obligations of appraisers, emphasizing integrity, impartiality, objectivity, independent judgment, and ethical conduct.
• Conflicts of Interest: Appraisers must avoid conflicts of interest, situations that could compromise their objectivity or create an appearance of bias. Examples include appraising properties in which the appraiser has a personal or financial interest, or accepting assignments from parties with whom the appraiser has a close personal relationship.
• Client Pressure: Resisting client pressure is a critical ethical challenge. Clients may attempt to influence appraisal results to meet their specific needs, such as achieving a desired loan amount or sale price. Appraisers must resist such pressure and provide unbiased opinions of value.
• Acceptance of Assignments: Appraisers may not accept appraisal assignments in which they have a bias toward the property or parties involved or a monetary incentive to provide a predetermined or biased opinion of value.
• Advocacy: Appraisers cannot be advocates in their appraisal assignments. Advocacy is representing the cause or interest of another, even if that cause or interest does not necessarily coincide with one’s own beliefs, opinions, conclusions, or recommendations.
• Compensation Structure: Appraisers should be compensated in a manner that avoids any incentive or the appearance of an incentive for deceptive practices. Most appraisers are paid by the hour or on a flat-fee basis, which provides little incentive to mislead a client or intended user. Appraisers must never accept fee arrangements that are contingent upon the outcome of the appraisal or the closing of a transaction.
• Confidentiality: Appraisers must maintain the confidentiality of appraisal assignments. They cannot disclose confidential information without the client’s consent, unless required by law or legal process.
• Competency: Appraisers must possess the necessary competency to perform appraisal assignments. This includes having the required knowledge, skills, and experience related to the specific property type, market area, and valuation techniques. If an appraiser lacks the necessary competency, they must decline the assignment or associate with a competent appraiser.

4. Mathematical Considerations in Ethical Practice

While appraisal ethics primarily concern behavioral standards, mathematical precision and transparency are also crucial for ethical practice. Here are some examples:
1. Data Integrity and Accuracy:
* All input data should be verified and sourced appropriately. If data is estimated, the estimation method must be clearly disclosed.
* Example: When calculating gross rent multiplier (GRM), the appraiser must ensure that both the gross rent and sale price are accurately recorded and comparable:
* GRM = Sale Price / Gross Rent
2. Statistical Analysis and Transparency:
* When employing statistical techniques (regression analysis, etc.), the appraiser should transparently report the analysis process, including the sample size (n), coefficient of determination (R^2), and standard error of the estimate (SEE).
* SEE = sqrt[ Σ (Y - Ŷ)^2 / (n - k - 1) ]
* Where:
* Y = Actual value
* Ŷ = Predicted value
* n = Sample size
* k = Number of independent variables
* High R^2 and low SEE do not automatically validate the model. The appraiser must also assess the underlying assumptions and potential biases.
3. Adjustments in Sales Comparison Approach:
* All adjustments must be based on market evidence and must be applied consistently. The methodology for determining the adjustment amount (e.g., paired sales analysis) should be documented.
* If an adjustment is subjective, the appraiser must clearly state that and provide a reasonable justification:
* Adjusted Sale Price = Sale Price ± Adjustment Amount
4. Discounted Cash Flow (DCF) Analysis:
* The selection of the discount rate (r) and the terminal capitalization rate (Rt) must be justified and supported by market data.
* Present Value (PV) = Σ CFt / (1 + r)^t + Terminal Value / (1 + r)^n
* Where:
* CFt = Cash flow in period t
* n = Number of periods
* Terminal Value = Net Operating Income (NOI) in period n+1 / Rt
* The appraiser must be transparent about the assumptions made regarding future cash flows, growth rates, and exit strategies.

5. Practical Applications and Experiments

1. Case Studies: Analyzing real-world appraisal scenarios that involve ethical dilemmas and discussing potential courses of action.
   • Example: An appraiser is asked by a lender to “hit a number” to ensure a loan closes. This violates ethical standards, as it compromises the appraiser’s objectivity. The appraiser should refuse to comply and document the request.
2. Role-Playing Exercises: Simulating appraisal assignments and requiring participants to navigate ethical challenges.
   • Example: One student plays the role of a client pressuring an appraiser (another student) to inflate the value of a property. The appraiser must ethically respond to the pressure.
3. Review of Appraisal Reports: Critiquing existing appraisal reports for compliance with USPAP and ethical standards.
   • Example: Examining a report to identify potential biases, conflicts of interest, or lack of transparency in the valuation process.

6. Conclusion

The appraisal profession demands high ethical standards and a commitment to providing❓ credible and unbiased valuation services. By understanding the evolution of the profession, licensing requirements, ethical obligations, and practical applications of ethical principles, aspiring appraisers can build successful and reputable careers.