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IN 1988, THE NEW YORK TIMES REPORTED that a cat named Tobias had been awarded an appraisal designation by the National Association of Real Estate Appraisers. This was a low blow for appraisers, who were already blamed for contributing to the $500 billion savings and loan boondoggle of the 1980s.
At that time, anyone could call themselves a real estate appraiser – even Tobias the cat. There are still over a dozen organizations representing the appraisal profession, each offering some form of private designation. Some designations, like the prestigious MAI awarded by the Appraisal Institute, are tough to earn. But many appraiser designations are still just meaningless titles dispensed by diploma mills.
All of this has changed with the advent of appraisal licensing. The appraisal profession has become much more respectable since Congress passed the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) in 1989, also known as the Savings and Loan Bailout Bill. Title XI of FIRREA, the Real Estate Appraisal Reform Amendment, required the licensing of real estate appraisers in all 50 states by the end of 1992. California began licensing appraisers on November 1, 1992.
The Uniform Standards of Professional Appraisal Practice
Probably the most significant event in the history of the appraisal profession has been the development of the Uniform Standards of Appraisal Practice (USPAP) mandated by FIRREA. These are strict guidelines, updated annually, which address professional appraisal standards, competency and ethics. USPAP has been adopted throughout the United States and is fast becoming the professional standard for appraisers throughout the world.
Appraisers who engage in fraud or unethical practice in violation of USPAP are now losing their licenses, getting stiff fines and even going to jail. Most appraisers who get in trouble say they are simply doing what their clients have always asked them to do. However, the burden of proof is now clearly on the appraiser – not the client – about accepting assignments which may violate professional and ethical standards.
Impartiality
Appraisers must perform their assignments with impartiality, objectivity and independence, and without accommodating any personal interests. For example, appraisers can’t take sides when they appraise property for divorces or partnership dissolutions. When giving expert legal testimony, appraisers can only advocate for their opinion of value, not for their client. Also, appraisers can’t be prejudiced regarding race, color, religion, national origin, gender, marital status, age, receipt of public assistance or handicaps.
One way appraisers maintain impartiality in a divorce case is to name both partners as co-clients, dealing only with the attorneys if possible. In litigation work, some appraisers offer to perform a preliminary investigation to determine whether or not an appraisal will benefit an attorney’s case before accepting an appraisal assignment.
Predetermined Values and Contingent Fees
Appraisers can’t accept assignments or base their fees contingent on the reporting of predetermined values, opinions or conclusions. For example, an appraiser can’t accept an assignment for appraising a house for a mortgage or home equity loan based on the value the lender or borrower needs to “make the deal.”
This, of course, is the most common ethical challenge that appraisers face. Probably 90 percent of all appraisals supporting purchase loans come in at or above the purchase price. However, the definition of market value uses the term “most probable price,” meaning that statistically half of these appraisals should come in below the sale price and a half should come in above.
The result is that many lenders may be loaning more money than they should. In a hot real estate market, values quickly rise beyond the inflated appraisals. But when the market cools off, we have the same problem that led to the savings and loan scandal of the 1980s, and the government may have to use taxpayer dollars to bail out the lending industry again.
Traditionally, honest appraisers who value property below the sale price get a reputation as “deal killers” and are often black listed by the people who order appraisals. Therefore, making appraisers adhere to strict professional and ethical standards has only solved part of the problem. The other and more serious part of the problem is the lenders, mortgage brokers, real estate agents and others who order the appraisals and control the appraisal process, and who earn commissions and fees based on the outcome of the appraisal.
Appraisers need to explain to their lender clients that in some cases they may be protecting them from making risky loans. Some appraisers approach these assignments by charging half their normal fee up front to inspect the property and select comparable sales. If it looks like the property won’t appraise high enough to make the deal, the client is out only half the fee and the appraiser has not compromised his or her ethical standards.
Real Estate Fraud and Flipping
The most widespread kind of real estate fraud involving appraisers is a practice called “flipping.” Flipping involves buying property and reselling it at inflated prices based on fraudulent appraised values. Lenders make large loans based on the inflated appraisals and those participating in the scam rake in the cash. The most common flipping scams involve FHA loans in low income areas.
Flipping usually involves some collusion between appraisers, real estate agents, mortgage brokers and title companies. But surprisingly, some appraisers have gotten conned into flipping scams without knowing what was going on. The unwitting appraiser usually accepts an out-of-area assignment with a fast turnaround time and uses comps supplied by the real estate agent who tells him or her what value they need to “make the deal.”
Property flipping scams are the main reason why appraisers are required to check the sales and listing history of the property being appraised. Appraisers should also check the history of the comparable sales.
Confidentiality and Record Keeping
An appraiser must protect the confidential nature of the appraiser-client relationship. The client is the person or persons who engages the appraiser. The appraiser can’t disclose confidential information or assignment results to anyone other than the client and “intended users” specifically authorized by the client. The appraiser must also maintain a work file for every assignment and keep the file for a specified number of years.
Some lender clients routinely ask appraisers to send them sample reports in order to get on “approved appraiser” lists. Appraisers should refuse these requests unless the appraiser has gotten specific permission from the client to release the report.
Competency, Out-of-Town Assignments and Unusual Properties
Prior to accepting an assignment, an appraiser must identify the problem and the scope of work, and must have the knowledge and experience to complete it. Otherwise, they must disclose their lack of knowledge and experience and take all necessary steps to complete the assignment competently. These steps may include further study, association with other appraisers or the use of other professionals (such as foresters, geologists, engineers, etc.).
One of the most common violations of the competency rule is when appraisers travel to other areas where they don’t understand the nuances of the local market or local neighborhoods. Appraisers who get out-of-area assignments should refer the jobs to local appraisers, get local appraisers to help them select comps or decline the assignment.
Other types of appraisals are so unusual that they should be referred to appraisers who specialize in this type of property and have access to nation-wide comparable sale information. Some examples of unusual properties include campgrounds, golf courses, bed and breakfast inns, health clubs and assisted living facilities.
Appraisal Development
USPAP makes a clear distinction between “appraisal development” and “appraisal reporting.” Developing an opinion of value is a process, whereas an appraisal report is a tangible object which conveys the result of the appraisal.
In developing an appraisal, appraisers must identify the problem to be solved and the scope of work necessary to solve the problem. They must do the research, verify the information and conduct the analysis necessary to produce a credible result. They must use methods and techniques which are generally recognized and accepted by the appraisal profession. They can’t commit a substantial error of commission or omission. And they can’t conduct the appraisal in a careless or negligent manner. In addition, the appraiser must identify the following.
- the client and intended users
- the intended use
- the type and definition of value
- the effective date of value
- the location, physical, legal and economic attributes of the property
- the real property interest being appraised
- any non-realty property included in the appraisal (personal property, trade fixtures, going concerns and intangible items)
- any easements, restrictions, encumbrances, leases and special assessments affecting the property
- the physical segments or partial interests being appraised
- the scope of work necessary to complete the assignment
- any extraordinary assumptions
- any hypothetical conditions
- any current agreements of sale, options or listings
- any prior sales of the property up to three years before the effective date of value
- the quality and quantity of available data analyzed
- the applicability or suitability of the valuation approaches used
Limited Appraisals, Drive-Bys and the Five Acre Request
The above is a list of the “binding” requirements that every licensed appraiser must follow in developing an opinion of value. In addition, there are a number of “specific” or optional requirements that must be included, as long as they are applicable and necessary to produce credible results.
Appraisers are allowed to perform limited appraisals by departing from these specific requirements, but only if the appraiser decides these steps aren’t necessary to produce credible results. Again, the burden of proof is on the appraiser, not the client.
The most common type of limited appraisal is the “drive-by” requested by lenders. The ethical challenge for the appraiser is to decide if they can appraise the property without inspecting it. If not, the appraiser should decline the assignment or insist on an interior inspection.
Another type of limited appraisal commonly ordered by lenders is the “five acre request.” In this assignment, the appraiser is asked to appraise a house on a large parcel and estimate the value of the house as if it were on a separate five acre lot. The appraiser must decide if using this hypothetical condition is credible or misleading. A more ethical solution would be to appraise the property as a whole by comparing it to similar properties, without using any hypothetical conditions.
Appraisal Reporting
As described above, there are two ways to develop an opinion of value – by using the complete appraisal process or the limited appraisal process. USPAP describes three ways of reporting these results – the self-contained report, the summary report and the restricted use report. Regardless of the type of report, the appraisal process remains the same.
The self-contained report is rarely used except in expert witness testimony, when the entire contents of the appraiser’s work file must be included in the report.
The summary report is the most common type of report. It can be a standard form report or a short narrative supported by documents in the appraiser’s work file.
The restricted use report can be in the form of a letter, and is limited to the use of the client, who is usually a real estate professional and is familiar with appraisals and with the property being appraised.
Appraisal Reviews
USPAP devotes a whole chapter to appraisal reviews, which are supplementary critiques intended for use in evaluating another appraiser’s work.
Appraisal reviews are far and away the leading cause of appraiser investigations by the California Office of Real Estate Appraisers (OREA). The problem is the clients who order appraisal reviews (predominantly lenders) have traditionally expected the review appraiser to include their own opinion of value along with the review (a sneaky way of getting a cheap appraisal). The appraiser can do this, of course, but then the assignment changes from a review to an appraisal, with all the requirements discussed above.
Appraisers who are asked to give an opinion of value as part of an appraisal review should explain the additional scope of work to their client or decline the assignment.
The Realtor Appraiser Conflict
The National Association of Realtors estimates that there are 31,000 licensed appraisers who belong to their organization. This is roughly 40 percent of the 80,000 or more licensed appraisers in the country. Realtor appraisers are licensed appraisers who also act as licensed real estate agents and brokers. As both a realtor and a licensed appraiser myself, I think the two skills go together naturally. In fact, I think more realtors should learn how to appraise correctly and more appraisers should learn how properties are actually bought and sold.
The ethical problem arises when real estate clients ask me for an opinion of value – either to help set a listing price or to help make a purchase offer. The Code of Ethics and Standards of Practice of the National Association of Realtors includes the following.
Standard of Practice 11-1
The obligations of the Code of Ethics shall be supplemented by and construed in a manner consistent with the Uniform Standards of Professional Appraisal Practice (USPAP) promulgated by the Appraisal Standards Board of the Appraisal Foundation. The obligations of the Code of Ethics shall not be supplemented by the USPAP where an opinion or recommendation of price or pricing is provided in pursuit of a listing, to assist a potential purchaser in formulation a purchase offer, or to provide a brokers price opinion, whether for a fee or not.
When I spoke with the California Office of Real Estate Appraisers (OREA), they weren’t so sure that this gets me off the hook. Their comment was that if my clients are making an important decision involving a lot of money based on my opinion of value, and if I have not arrived at that opinion according to the requirements of USPAP, I could be potentially liable. They felt that this issue will ultimately be resolved when a realtor appraiser is sued by a client and the courts establish a legal precedent. Unless I wanted to be the test case, they suggested I continue to follow USPAP at all times whenever I render an opinion of value.
Many sellers think their properties are worth much more than they really are. Therefore it’s tempting for unethical real estate agents to compete for listings by presenting sellers with an inflated “comparative market analysis” or CMA. Realtor appraisers who do this put themselves in double jeopardy because they are violating the standards and ethics of both professions.
I know that smart, motivated sellers have their properties fully inspected, put in top condition, get them accurately appraised and set a reasonable asking price. When I’m asked to give a listing presentation, the first thing I require is for the seller to engage me (or someone else) to conduct a regular appraisal (not a CMA). If I do the appraisal I charge my regular fee, which is not contingent on whether or not I get the listing or eventually sell the property. If it appears that the seller does not want an honest opinion of value, does not intend to set a realistic listing price, or does not intend to put the property in good selling condition, I refer them to another agent. I get a potential referral fee from the other agent and I avoid wasting my time with a client who is probably not a serious seller.
When buyers ask me what I think a property is worth, I decline to answer unless they engage me (or someone else) to conduct an appraisal. If I appraise the property I charge my regular fee, which is not contingent on whether or not they make an offer or eventually buy the property. Buyers who have looked at a lot of comparable properties tend to develop a good sense of market value. However, for unusual or unique properties, they may wish to have the property appraised or make their offer contingent on the property appraising for at least the selling price.
The realtor appraiser conflict has not been fully resolved, either legally or ethically. In the meantime, realtor appraisers may wish to refer valuation assignments to other appraisers when they involve a property they are helping to buy or sell, to avoid the appearance of any conflict of interest.
Approved Appraisers and Fee Panels
In the days before appraiser licensing, and before the current wave of big bank mergers, many lenders employed in-house appraisers or maintained a “fee panel” of “approved” independent appraisers to support their loans. Appraisers often had to wait for years to get on these lists, submit resumes and work samples and even pay a fee.
Once the appraiser was on the approved list, the lender would give that appraiser all the work they could handle in a particular area. In return, the appraiser was expected to give rapid turnaround times, reduced fees, extend generous terms, do rush assignments and even the occasional out-of-area job. However, many lenders abused this arrangement by asking the appraiser to produce predetermined values, ignore defects and use inappropriate appraisal methods in order to “make the deal.”
The appraiser was faced with the choice of doing occasionally unethical work or losing an important client. Approved appraiser lists and fee panels still exist, but they are becoming less important now as banks merge and must service much larger territories.
Appraisal Management Companies
Merger mania has broken up the fee panel system and spawned a new enterprise called the appraisal management company. These AMCs contract with large lenders for appraisal services all over the country. They farm the work out to independent appraisers and tack on a substantial commission for their role as the middle man. Appraisal management companies have been compared to health management organizations (HMOs). The consumer pays more, the service provider earns less and the quality of the product is inferior.
AMCs usually order limited appraisals, demand fast turnaround times and pay about half the regular appraisal fee. Therefore, they tend to attract a lot of inexperienced entry-level appraisers. In the old days, appraisers learned their trade by serving an apprenticeship with an older, more experienced appraiser, usually on some sort of fee split basis. Now many appraisers start out working for AMCs and aren’t exposed to traditional ethics and professional standards.
Automated Valuation Models
The latest blow to the appraisal profession is the so-called “computerized appraisal.” In order to speed up the loan approval process, many lenders are using a new kind of computer program called the automated valuation model (AVM). Technically, AVMs and the reports they produce are only appraisal tools, not appraisals. USPAP defines an appraisal as an “opinion of value.” Computers, so far, have not been able to develop opinions, ethics or professional standards.
How well do these AVMs work? Not very well yet, but only because real estate data, especially in rural areas, still isn’t very accurate or complete. In urban areas with good data this technology will probably put a lot of appraisers out of work.
In the future, the ideal combination will be a well-designed automated valuation model in the hands of an experienced appraiser, providing faster service at lower cost, but tempered by ethics and professional standards.
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