Appraisal Review: Process and Standards

Appraisal Review: Process and Standards

Introduction

Appraisal review is a critical component of the real estate valuation process, ensuring accuracy, reliability, and compliance. It provides an independent assessment of an appraisal report’s credibility and completeness. This chapter will explore the appraisal review process in detail, covering relevant standards, methodologies, and practical considerations.

1. Defining Appraisal Review

Appraisal review is the act or process of developing and communicating an opinion about the quality of another appraiser’s work that was performed as part of an appraisal assignment. An appraisal review may also provide an opinion of value (USPAP, 2020-2021 edition). The objective of an appraisal review is to determine whether the original appraisal is credible, reliable, and complies with relevant professional standards (e.g., USPAP).

2. The Need for Appraisal Review

Appraisal reviews are requested for various reasons, including:
* Quality Control: Lenders and investors use reviews as a quality control measure to ensure the accuracy and reliability of appraisals, particularly for high-value loans.
* Regulatory Compliance: Banks and financial institutions often require reviews to satisfy regulatory requirements and minimize risk.
* Risk Management: Reviews help identify potential errors or deficiencies in appraisals that could impact investment decisions.
* Litigation Support: Attorneys may use appraisal reviews to challenge or support valuation opinions in legal proceedings (e.g., condemnation).
* Secondary Market Requirements: Entities like Fannie Mae and Freddie Mac often require reviews of appraisals for loans they purchase or guarantee. As the provided PDF indicates “use of Fannie Mae Form 2000/ Freddie Mac Form 1032 is required for review assignments performed for these two entities.”

3. Parties Involved in the Appraisal Review Process

• Client: The individual or entity requesting the appraisal review.
• Reviewer: The appraiser performing the appraisal review.
• Original Appraiser: The appraiser who prepared the initial appraisal report.
• Intended Users: The parties who will rely on the appraisal review report, as identified by the reviewer.

4. Scope of Work in Appraisal Review

The scope of work (SOW) in an appraisal review defines the extent of research and analysis required. It’s essential to define the SOW upfront to ensure the review addresses the client’s needs and complies with professional standards.

The SOW must include, at a minimum:

• Identifying the problem: Defining the intended use and intended users of the appraisal review.
• Determining the scope of work necessary to solve the problem: This includes the extent of research and analysis, whether it involves a desk review or a field review.
• Disclosing the scope of work in the report: Communicating the scope of work clearly to the client and intended users.

The scope of work must be sufficient to produce credible results.

5. Levels of Appraisal Review

Appraisal reviews can be categorized into different levels based on the scope of work:

• Desk Review: A limited review conducted remotely, focusing on the appraisal report’s completeness, consistency, and compliance with standards. Typically the reviewer doesn’t physically inspect the subject property❓.
• Field Review: A more comprehensive review that includes a physical inspection of the subject property and comparable sales, as well as an in-depth analysis of the appraisal report.
• Technical Review: Focuses on the technical aspects of the appraisal, such as data accuracy, methodology, and calculations.
• Administrative Review: Ensures the appraisal complies with administrative requirements, such as formatting, documentation, and certifications.

6. Appraisal Review Standards and Guidelines

• Uniform Standards of Professional Appraisal Practice (USPAP): USPAP Standard 3 specifically addresses appraisal review. It outlines the requirements for developing and reporting appraisal review assignments.
• Interagency Appraisal and Evaluation Guidelines: These guidelines provide regulatory guidance for federally regulated financial institutions regarding appraisal review practices.
• Appraisal Institute: The Appraisal Institute offers guidance and resources for appraisal reviewers, including best practices and professional development courses.

7. Key Elements of the Appraisal Review Process

1. Engagement: Accepting the assignment.
   • Reviewer must have the knowledge and experience to complete the review assignment competently.
   • Reviewer must be independent, objective, and impartial.
2. Preliminary Analysis: Understanding the original appraisal report.
   • Review the original appraisal report to identify its purpose, scope, and conclusions.
   • Understand the characteristics of the subject property and market area.
3. Data Verification: Validating the data used in the appraisal.
   • Verify the accuracy of the data used in the appraisal, including property characteristics, market data, and comparable sales.
   • Use reliable sources such as public records, MLS data, and third-party vendors.
4. Methodology Review: Assessing the appropriateness of the appraisal methods.
   • Evaluate the appropriateness of the appraisal methods used in the original appraisal, such as the sales comparison approach, cost approach, and income approach.
   • Consider the property type, market conditions, and data availability.
5. Analysis and Reconciliation: Developing an independent opinion.
   • Analyze the data, methodology, and conclusions presented in the appraisal report.
   • Form an independent opinion about the credibility and reliability of the appraisal.
   • Reconcile any discrepancies or inconsistencies.
6. Reporting: Communicating the review findings.
   • Prepare a clear and concise appraisal review report.
   • Include the purpose of the review, scope of work, findings, and conclusions.
   • Comply with USPAP reporting requirements.

8. Key Areas of Focus During Appraisal Review

• Property Description: Verify the accuracy of the property description, including size, condition, and features.
• Market Analysis: Evaluate the market analysis to ensure it reflects current market conditions and trends.
• Comparable Sales: Assess the selection and analysis of comparable sales, including adjustments for differences. The comparable sales must adhere to the principles of substitution. The principle of substitution states that a rational buyer will pay no more for a property than they would pay for an equally desirable substitute.
• Valuation Methods: Examine the application of the sales comparison, cost, and income approaches.
  • Sales Comparison Approach:
    • Formula: Indicated Value = Sale Price of Comparable ± Adjustments
  • Cost Approach:
    • Formula: Value = Cost of Reproduction/Replacement - Accrued Depreciation + Land Value
  • Income Approach:
    • Direct Capitalization: Value = Net Operating Income❓❓ (NOI) / Capitalization Rate (R)
    • Discounted Cash Flow (DCF): Value = Σ [Cash Flow t / (1 + r)t], where ‘t’ is the time period and ‘r’ is the discount rate.
• Reconciliation: Evaluate the reconciliation of the different value indications into a final value opinion.
• Compliance: Ensure the appraisal complies with USPAP and other relevant standards.

9. Potential Issues Identified During Appraisal Review

• Inadequate Data: Insufficient or unreliable data used in the appraisal.
• Methodological Errors: Incorrect application of appraisal methods or techniques.
• Unsupported Adjustments: Adjustments to comparable sales without sufficient support.
• Bias: Evidence of bias or advocacy in the appraisal.
• Lack of Objectivity: Lack of impartiality in the analysis and conclusions.

10. Reporting Appraisal Review Results

An appraisal review report should clearly communicate the reviewer’s findings and conclusions. It should include:

• Identification of the appraisal under review: Including the date, appraiser, and client.
• Scope of work: Describing the extent of the review.
• Summary of findings: Highlighting any issues or deficiencies identified.
• Opinion of credibility: Stating whether the appraisal is credible and reliable.
• Opinion of value: Providing an independent opinion of value, if required by the scope of work.
• USPAP compliance statement: Certifying that the review complies with USPAP.

11. USPAP Standard 3: Performing an Appraisal Review

USPAP Standard 3 outlines the specific requirements for performing appraisal review assignments:

• Competency: The reviewer must be competent to perform the review.
• Scope of work: The reviewer must develop a scope of work that is appropriate for the assignment.
• Objectivity: The reviewer must be objective and impartial.
• Reporting: The reviewer must communicate the review findings in a clear and concise manner.

12. Mathematical Considerations in Appraisal Review

Appraisal review often involves analyzing mathematical calculations and models used in the original appraisal. This includes:

• Statistical Analysis: Reviewing statistical measures used in market analysis and comparable sales analysis. This could include mean, median, standard deviation and regression analysis.
• Discounted Cash Flow (DCF) Analysis: Analyzing the inputs and assumptions used in DCF models. This involves understanding time value of money, discount rates, and cash flow projections. As previously mentioned the formula is Value = Σ [Cash Flow t / (1 + r)t], where ‘t’ is the time period and ‘r’ is the discount rate.
• Capitalization Rate Analysis: Reviewing the development and application of capitalization rates. This involves understanding the relationship between income, value, and rate of return ( Value = Net Operating Income (NOI) / Capitalization Rate (R)).
• Regression Analysis: Reviewing the application of statistical regression models to the valuation of real estate.

13. Ethical Considerations in Appraisal Review

Appraisal reviewers have a responsibility to act ethically and with integrity. This includes:

• Confidentiality: Maintaining the confidentiality of client information.
• Independence: Avoiding conflicts of interest.
• Objectivity: Remaining objective and impartial.
• Transparency: Disclosing any limitations or biases.

14. Common Errors in Appraisal Reports

Reviewers should be aware of common errors that occur in appraisal reports, including:

• Data Errors: Inaccurate or outdated data.
• Calculation Errors: Mistakes in mathematical calculations.
• Omission Errors: Failure to include relevant information.
• Judgment Errors: Subjective opinions unsupported by data.

15. Example of a Practical Application

Consider an appraisal of a commercial building using the income approach. The original appraisal used a capitalization rate of 8% based on regional market data. During the review, the reviewer discovers that local market data indicates a more appropriate capitalization rate of 9% for similar properties.

Using the formula Value = Net Operating Income (NOI) / Capitalization Rate (R), the reviewer recalculates the value using the 9% capitalization rate. This results in a lower value opinion, indicating that the original appraisal may be overstated.

16. Conclusion

Appraisal review is a vital process for ensuring the accuracy and reliability of real estate valuations. By following established standards, guidelines, and best practices, reviewers can provide valuable insights and support sound decision-making in the real estate industry.