Foundations of Appraisal Review: Purpose and Standards

Chapter: Foundations of Appraisal Review: Purpose and Standards

Introduction

Appraisal review is a critical component of maintaining quality and accuracy within the real estate valuation profession. This chapter establishes the foundational principles of appraisal review, emphasizing its purpose, the standards that govern its practice, and the scientific underpinnings that ensure its reliability. Understanding these foundations is essential for anyone seeking to master appraisal review and ensure the integrity of real estate valuations.

1. The Purpose of Appraisal Review

Appraisal review serves several vital functions within the real estate and financial sectors. It is not merely about fault-finding; it’s a structured process aimed at ensuring that appraisals meet established standards and are credible.

• Quality Control: Appraisal reviews act as a key mechanism in quality control processes. By scrutinizing appraisal reports, reviewers identify potential errors, omissions, or biases that could affect the accuracy of the value opinion. This is analogous to statistical process control where deviations from the norm trigger further investigation.
• Risk Mitigation: For lenders, investors, and other stakeholders, appraisal review mitigates risk by providing an independent assessment of the appraisal’s validity. A flawed appraisal can lead to poor investment decisions, defaults, and financial losses. Independent review enhances decision-making confidence.

• Compliance: Many regulatory bodies and institutional investors require appraisal reviews to ensure compliance with established guidelines, such as the Uniform Standards of Professional Appraisal Practice (USPAP) and internal risk management policies.

  Example: A bank may require a desk review of all appraisals exceeding a certain loan amount as part of its risk management protocol. If the initial appraisal suggests a property value (V) significantly higher than the loan amount (L), and the loan-to-value ratio (LTV = L/V) is outside acceptable limits, the review is triggered to confirm appraisal integrity.
  * Litigation Support: Appraisal reviews are frequently used in legal disputes involving property valuation, such as eminent domain cases, tax appeals, and divorce proceedings. An appraisal reviewer can act as an expert witness, providing an objective critique of the appraisal methodology and conclusions.
  * Professional Development: For appraisers, undergoing appraisal review can be a valuable learning experience. Constructive feedback from reviewers helps appraisers improve their skills and avoid common pitfalls.

2. Defining Appraisal Review

Appraisal review is defined as the act or process of developing and communicating an opinion regarding the quality of another appraiser’s work.

• This can include, but is not limited to, identifying errors, inconsistencies, or biases in the original appraisal.
• It may also involve forming an independent opinion of value.

3. Standards Governing Appraisal Review

Appraisal review is governed by a complex set of standards designed to ensure impartiality, objectivity, and competence. The Uniform Standards of Professional Appraisal Practice (USPAP) is the cornerstone of these standards.

• USPAP Standard 3: USPAP specifically addresses appraisal review. It outlines the requirements for developing and reporting an appraisal review assignment. Key aspects include:
  • Identifying the work under review.
  • Identifying the intended use and intended users of the review.
  • Disclosing the scope of work performed in the review.
  • Developing an opinion regarding the completeness, accuracy, adequacy, relevance, and credibility of the work under review.
  • Reporting the results of the review in a clear and understandable manner.
• Competency Rule: The Competency Rule of USPAP requires that appraisers (and reviewers) possess the necessary knowledge and experience to perform the assignment competently. If lacking competency, the reviewer must either decline the assignment or take steps to achieve competency, such as partnering with a more experienced reviewer.
• Ethics Rule: The Ethics Rule of USPAP mandates that appraisers (and reviewers) act with integrity, impartiality, and objectivity. Conflicts of interest must be disclosed, and confidential information must be protected.
• Jurisdictional Exception Rule: If any part of USPAP is contrary to law or public policy in a specific jurisdiction, the Jurisdictional Exception Rule allows for deviation from USPAP to the extent required by law.

4. Independence and Objectivity

Maintaining independence and objectivity is paramount in appraisal review. Reviewers must avoid any conflicts of interest that could compromise their ability to provide an unbiased assessment.

• Conflicts of Interest: Conflicts of interest can arise from various sources, such as:
  • A prior relationship with the appraiser whose work is being reviewed.
  • A financial interest in the property being appraised.
  • Pressure from the client to reach a specific conclusion.
• Mitigating Conflicts: To mitigate conflicts of interest, reviewers should:
  • Disclose any potential conflicts to the client.
  • Recuse themselves from assignments where a conflict cannot be effectively managed.
  • Adhere to strict ethical guidelines.

• Statistical Analysis: Consider a situation where a reviewer suspects bias in the original appraisal’s selection of comparable sales. A statistical analysis can be performed to assess whether the selected comparables represent a random sample of available sales or if they are systematically skewed to support a predetermined value.

  • Null Hypothesis (H0): The selected comparables are a random sample.
  • Alternative Hypothesis (H1): The selected comparables are not a random sample.

  If a statistical test (e.g., a chi-squared test or Kolmogorov-Smirnov test) yields a p-value below a predetermined significance level (α), the null hypothesis is rejected, suggesting potential bias.
  Example: A reviewer can perform regression analysis on comparable sales data. If the appraised value deviates significantly from the regression prediction, this indicates a potential issue.

5. Scope of Work in Appraisal Review

The scope of work in an appraisal review defines the extent of the reviewer’s investigation and analysis. The scope of work must be carefully defined and clearly communicated in the review report.

• Factors Influencing Scope: The scope of work is influenced by factors such as:
  • The intended use of the review.
  • The complexity of the appraisal under review.
  • The client’s requirements.
  • The available data.
• Types of Reviews: Common types of reviews include:
  • Desk Review: A review performed remotely, based solely on the appraisal report and readily available data sources.
  • Field Review: A review that includes a physical inspection of the subject property and/or comparable sales.
  • Technical Review: A review focused on the technical aspects of the appraisal, such as the appraisal methodology, data analysis, and calculations.
• Sampling and Auditing: In large-scale review projects, statistical sampling techniques may be used to select a subset of appraisals for review. This allows for efficient assessment of the overall quality of a portfolio.

  • Sample Size Calculation: The required sample size (n) can be calculated using formulas that consider factors such as the population size (N), the desired confidence level (Z), the acceptable margin of error (E), and the estimated population proportion (p).

    n = (Z^2 * p * (1-p)) / E^2
    Example: To determine the percentage of appraisals in a mortgage portfolio with material errors, a reviewer can use stratified sampling. After dividing the portfolio into loan size categories (e.g., less than \$200,000, \$200,000 to \$500,000, over \$500,000), a random sample is taken from each group. This allows the reviewer to estimate the total error rate in the portfolio.

6. Developing an Opinion in Appraisal Review

The core of appraisal review involves developing an opinion regarding the quality of the work under review. This opinion must be supported by credible evidence and logical reasoning.

• Evaluating Completeness: Assessing whether the appraisal report includes all necessary information, such as a clear description of the subject property, a thorough market analysis, and adequate support for the value opinion.
• Assessing Accuracy: Verifying the accuracy of the data presented in the appraisal report, such as property characteristics, sales prices of comparable sales, and market trends.
• Determining Adequacy: Evaluating whether the appraisal methodology is appropriate for the assignment and whether the data analysis is sufficient to support the value opinion.
• Establishing Relevance: Determining whether the data and analysis presented in the appraisal report are relevant to the valuation problem.
• Validating Credibility: Assessing the overall credibility of the appraisal report, considering factors such as the appraiser’s qualifications, the consistency of the analysis, and the reasonableness of the value opinion.
• Quantitative Analysis Techniques:
  • Sensitivity Analysis: Evaluating how changes in key assumptions (e.g., discount rate, growth rate) affect the value conclusion.
  • Regression Analysis: Comparing the appraised value to a statistically derived value based on market data.
    Example: A reviewer assessing the sales comparison approach might compare the adjustments made by the appraiser for differences between the subject property and comparable sales to market-derived adjustments. If the appraiser adjusted for a swimming pool by \$50,000 but a market analysis shows pools contribute only \$30,000, this variance must be explained.

7. Reporting the Appraisal Review Opinion

The results of the appraisal review must be communicated in a clear, concise, and understandable manner. The review report should adhere to USPAP guidelines and include all necessary disclosures.

• Essential Components of a Review Report:
  • Identification of the work under review.
  • Statement of the purpose and intended use of the review.
  • Description of the scope of work performed.
  • Summary of the reviewer’s findings and conclusions.
  • Disclosure of any conflicts of interest.
  • Certification by the reviewer.
• Clarity and Objectivity: The review report should avoid ambiguous language, unsupported assertions, and personal attacks. The focus should be on the objective assessment of the appraisal under review.
• Format: Review reports may be delivered in various formats, from simple letters to detailed narrative reports. The chosen format should be appropriate for the complexity of the assignment and the needs of the client.

8. Conclusion

Appraisal review is a multifaceted discipline that demands both technical expertise and unwavering adherence to ethical standards. By understanding the purpose of appraisal review, the standards that govern its practice, and the scientific principles that underpin its reliability, professionals can contribute to the integrity and accuracy of real estate valuations. Mastery of these foundational elements is essential for anyone seeking to excel in the field of appraisal review and ensure that appraisal services are credible.