Appraisal Review: Validating Reports

Chapter: Appraisal Review: Validating Reports

Introduction

This chapter delves into the critical process of appraisal review, focusing on validating the accuracy and quality of appraisal reports. Appraisal review is not merely a cursory examination; it is a systematic and scientific analysis aimed at ensuring the credibility and reliability of valuation conclusions. We will explore the underlying principles, methodologies, and professional standards that guide effective appraisal review, equipping you with the tools and knowledge necessary to master this essential aspect of the appraisal profession.

1. The Science of Validation in Appraisal Review

Validation, in the context of appraisal review, involves objectively assessing the soundness of an appraisal report’s methodology, data, analysis, and conclusions. This process relies on established scientific principles and statistical techniques to determine the degree to which the report accurately reflects market realities and adheres to accepted appraisal standards.

• 1.1. Core Principles:

  • Objectivity: Reviewers must maintain impartiality and avoid bias in their assessment. This requires separating personal opinions from factual evidence and methodological rigor.

  • Verifiability: All data, assumptions, and analyses presented in the original appraisal report must be traceable and verifiable. Reviewers must be able to independently confirm the sources and accuracy of information used.

  • Repeatability: The appraisal methodology should be sufficiently clear and well-documented that another qualified appraiser could, using the same data and techniques, arrive at a similar conclusion.

  • Transparency: The report must clearly disclose all relevant information, including data sources, assumptions, limitations, and the reasoning behind the valuation conclusion.

• 1.2. Scientific Theories and Principles:

  • Regression Analysis: This statistical technique is often used to analyze the relationship between property characteristics (independent variables) and market value (dependent variable). Reviewers can use regression analysis to test the validity of the original appraiser’s adjustments for property differences. For example, a simple linear regression model could be expressed as:

    Y = a + bX + ε

    Where:

    Y = predicted market value❓❓

    a = Intercept (value when X = 0)

    b = Regression coefficient (change in Y for each unit change in X)

    X = Property characteristic (e.g., square footage, lot size)

    ε = Error term

    By comparing the regression model used by the original appraiser with their own analysis, reviewers can identify potential biases or inaccuracies in the adjustments.

  • Statistical Significance: Reviewers must evaluate the statistical significance of the data and analyses used in the appraisal report. For instance, if a sample of comparable sales is used, the reviewer should assess whether the sample size is adequate and the results are statistically significant. This can be assessed through p-values and confidence intervals.

  • Spatial Statistics: In some cases, location plays a crucial role in property value. Spatial statistics techniques, such as spatial autocorrelation, can be used to analyze the patterns of property values and identify clusters or outliers.
  • Sampling Theory: If the original appraiser used a sample of data (e.g., comparable sales, vacancy rates), the reviewer should evaluate the sampling methodology to ensure that the sample is representative of the population. This involves assessing the sample size, sampling method (e.g., random sampling, stratified sampling), and potential biases. The sample size n required to estimate a population parameter within a desired margin of error E can be determined using formulas such as:

  For estimating a population mean: n = (z * σ / E)^2

  Where:

  z = z-score corresponding to the desired confidence level

  σ = Population standard deviation (estimated from a pilot study or prior data)

  E = Desired margin of error

• 1.3. Practical Applications and Related Experiments:

  • Comparable Sales Analysis Validation:
    1. Experiment: Select a sample of appraisal reports with comparable sales analyses.
    2. Procedure: Independently gather data on the same comparable sales, including transaction dates, sale prices, and property characteristics.
    3. Analysis: Use statistical methods to compare the appraiser’s adjustments with your own analysis. Calculate the percentage difference between the adjusted sale prices and the subject property’s value.
    4. Conclusion: Identify any significant discrepancies or biases in the appraiser’s analysis.
  • Cost Approach Validation:
    1. Experiment: Select a sample of appraisal reports using the cost approach.
    2. Procedure: Independently estimate the replacement cost of the subject property using reliable cost data sources (e.g., Marshall & Swift, R.S. Means).
    3. Analysis: Compare the appraiser’s cost estimates with your own estimates. Analyze any differences in the depreciation estimates.
    4. Conclusion: Identify any significant errors or inconsistencies in the cost approach.
  • Income Approach Validation:
    1. Experiment: Select a sample of appraisal reports using the income approach.
    2. Procedure: Independently analyze the subject property’s income and expense data, research market capitalization rates, and estimate the property’s market value.
    3. Analysis: Compare the appraiser’s income approach analysis with your own analysis. Identify any differences in the income and expense projections, capitalization rates, and value estimates.
    4. Conclusion: Identify any significant errors or inconsistencies in the income approach.

2. Identifying and Addressing Deficiencies

A crucial aspect of appraisal review is identifying and addressing deficiencies in the original appraisal report. These deficiencies can range from minor errors to significant methodological flaws that undermine the credibility of the valuation conclusion.

• 2.1. Common Types of Deficiencies:

  • Data Errors: Inaccurate or incomplete data, such as incorrect property characteristics, sales prices, or financial information.

  • Methodological Flaws: Incorrect application of appraisal techniques, such as using inappropriate comparable sales, failing to account for market conditions, or miscalculating adjustments.

  • Analytical Errors: Errors in reasoning or analysis, such as drawing unsupported conclusions, failing to consider relevant factors, or using flawed statistical techniques.

  • Reporting Deficiencies: Lack of clarity, transparency, or compliance with appraisal standards, such as failing to adequately disclose assumptions, limitations, or the reasoning behind the valuation conclusion.

• 2.2. Systematic Approach to Identifying Deficiencies:

  1. Review the Scope of Work: Understand the original appraiser’s assignment, intended use, and client requirements.
  2. Examine the Data: Verify the accuracy and completeness of the data used in the report.
  3. Evaluate the Methodology: Assess the appropriateness and accuracy of the appraisal techniques used.
  4. Analyze the Reasoning: Evaluate the logic and support for the appraiser’s conclusions.
  5. Assess the Reporting: Ensure compliance with appraisal standards and clear communication of findings.
  6. Document All Findings: Keep detailed records of all deficiencies identified and the basis for your conclusions.

• 2.3. Addressing Deficiencies:

  • Communicate with the Original Appraiser: If possible, discuss the deficiencies with the original appraiser and provide an opportunity for them to respond or revise the report.
  • Provide Corrective Actions: Clearly explain the nature of the deficiencies and provide specific recommendations for correcting them.
  • Develop Your Own Opinion of Value: If the deficiencies are significant and cannot be adequately addressed, develop your own independent opinion of value based on a thorough analysis of the market data and property characteristics.
  • Document Your Analysis: Clearly document your analysis and the reasoning behind your opinion of value in the review report.

3. Adherence to Professional Standards and Ethical Considerations

Appraisal review is governed by a stringent set of professional standards and ethical considerations. Adherence to these standards is essential for maintaining the credibility and integrity of the appraisal profession.

• 3.1. Relevant Professional Standards:

  • Uniform Standards of Professional Appraisal Practice (USPAP): Standard 3 of USPAP specifically addresses appraisal review. It outlines the requirements for developing and reporting appraisal review assignments.
  • Appraisal Institute Standards: The Appraisal Institute also publishes its own set of standards and ethics that apply to its members.
  • Fannie Mae and Freddie Mac Guidelines: These agencies have specific requirements for appraisal reviews performed for loans they purchase or guarantee.
  • Federal Regulations: Federal regulations, such as those issued by the FDIC, OCC, and FRB, also address appraisal review requirements for federally regulated institutions.

  • 3.2. Key Ethical Considerations:

  • Independence: Reviewers must maintain independence and avoid conflicts of interest.

  • Objectivity: Reviewers must be impartial and unbiased in their assessment of the appraisal report.
  • Confidentiality: Reviewers must protect the confidentiality of the information contained in the appraisal report.
  • Competency: Reviewers must be competent to perform the appraisal review assignment.
  • Disclosure: Reviewers must disclose any relevant information that may affect their objectivity or the credibility of the review.
  • 3.3. Impact of Non-Compliance:

  Failure to comply with professional standards and ethical considerations can result in disciplinary actions, legal liability, and damage to reputation.

4. The Appraisal Review Report: Communicating Findings

The appraisal review report is the primary means of communicating the reviewer’s findings and conclusions to the client. The report must be clear, concise, and well-supported by evidence.

• 4.1. Essential Components of an Appraisal Review Report:

  The Student Handbook to THE APPRAISAL OF REAL ESTATE, 14TH EDITION provides a list of components that meet professional standards:

  1. The client and intended users of the review
  2. The intended use of the review
  3. The objective of the review
  4. The subject of the review assignment
  5. The ownership interest of the subject property of the work under review
  6. The date of the work under review
  7. The effective date of the conclusions of the work under review
  8. The name of the appraiser
  9. The effective date of the review
  10. Extraordinary assumptions and hypothetical conditions used by the reviewer (and a statement that their use might affect the conclusions)
  11. The reviewer’s scope of work
  12. The reviewer’s opinions and conclusions
  13. The reviewer’s opinion of value, the reasoning behind this opinion, and a statement explaining which segments of the appraisal were considered credible and what additional information was used in the review (if part of the review assignment’s scope of work)
  14. The reviewer’s signed certification

• 4.2. Clearly Articulating the Scope of Work: The review report must clearly define the scope of work performed, including the data examined, the methodology used, and the limitations of the review.

• 4.3. Providing a Supported Opinion of Value: If the scope of work requires the reviewer to develop an opinion of value, the report must provide a clear and well-supported explanation of the reasoning behind the opinion.

• 4.4. Maintaining a Workfile: Reviewers must maintain a workfile that documents the data, analysis, and reasoning behind their conclusions. This workfile should include a copy of the original appraisal report, any additional information used in the review, and the reviewer’s signed certification.

Conclusion

Mastering appraisal review requires a deep understanding of scientific principles, appraisal methodologies, and professional standards. By applying a systematic and objective approach, reviewers can effectively validate appraisal reports, identify deficiencies, and ensure the credibility and reliability of valuation conclusions. This chapter has provided a comprehensive overview of the essential elements of appraisal review, equipping you with the knowledge and tools necessary to excel in this critical aspect of the appraisal profession.