Tag Archives: valuation

The Uniform Appraisal Dataset

This article first appeared in Appraisal Today. Thank you Ann O’Rourke for publishing!

 

The Uniform Appraisal Dataset (UAD) was designed to help bring some uniformity into the appraisal process related to mortgage work. After all, appraisers were not very uniform in the way they described condition and quality.  This applied not just to condition and quality ratings, but to a myriad of other factors such as view and location, down to how basement finish was identified. The Collateral Underwriter (CU) was designed in part to synthesize all of this information and also to identify areas where appraisers differed markedly from each other, as well as even within their own work product.

We had a lot of angst at the outset of CU related to reusing quality and condition ratings, and possibly changing them from one report to another. This was a valid concern because it is one of the factors that does get measured within the CU.  Since the UAD has been required since 2011 for mortgage related work intended for Fannie Mae or Freddie Mac, we would expect, five years after the fact, that appraisers would be well versed with what the specific ratings entailed. As both a reviewer and appraiser in the field, I find this is unfortunately far from the truth. The truth seems to be, that confusion related to the requirements is still rampant, and my contention is, that it is not the appraisers who are at fault, but the definitions themselves. There are simply too many grey areas. Either that, or education has not been sufficient in helping appraisers understand what is expected. It is a good possibility however, based on the continued widespread variances, that the definitions themselves are too vague.

Let us take a look at quality for a Q4 and a Q5 house. The ratings in the 1004 form show:

Q4 Dwellings with this quality rating meet or exceed the requirements of applicable building codes. Standard or modified standard building plans are utilized and the design includes adequate fenestration and some exterior ornamentation and interior refinements. Materials, workmanship, finish, and equipment are of stock or builder grade and may feature some upgrades.

Q5 Dwellings with this quality rating feature economy of construction and basic functionality as main considerations. Such dwellings feature a plain design using readily available or basic floor plans featuring minimal fenestration and basic finishes with minimal exterior ornamentation and limited interior detail. These dwellings meet minimum building codes and are constructed with inexpensive, stock materials with limited refinements and upgrades.

Q4 indicates stock builder grade and may feature some upgrades. Q5 indicates basic finishes and inexpensive, stock materials with limited refinements and upgrades. Both say stock, but Q4 says it may feature some upgrades. What are these upgrades? Are they upgrades to cabinetry, or are they upgrades to the building itself? Does taking a standard high-volume production build quality for the starter market, but adding higher-end cabinetry bump the quality level up?

What about condition? Probably the two ratings that are utilized the most are C3 and C4, which are as follows:

C3 The improvements are well maintained and feature limited physical depreciation due to normal wear and tear. Some components, but not every major building component, may be updated or recently rehabilitated. The structure has been well maintained.

*Note: The improvement is in its first-cycle of replacing short-lived building components (appliances, floor coverings, HVAC, etc.) and is being well maintained. Its estimated effective age is less than its actual age. It also may reflect a property in which the majority of short-lived building components have been replaced but not to the level of a complete renovation.

C4 The improvements feature some minor deferred maintenance and physical deterioration due to normal wear and tear. The dwelling has been adequately maintained and requires only minimal repairs to building components/mechanical systems and cosmetic repairs. All major building components have been adequately maintained and are functionally adequate.

 *Note: The estimated effective age may be close to or equal to its actual age. It reflects a property in which some of the short-lived building components have been replaced, and some short-lived building components are at or near the end of their physical life expectancy; however, they still function adequately. Most minor repairs have been addressed on an ongoing basis resulting in an adequately maintained property

Given the scenario that follows, the C3 and C4 ratings are most likely in play, and the difference between the two are that on C3, that some components may be updated or recently rehabilitated and well maintained, and on C4 they are adequately maintained and functionally adequate. What about quality ratings for this same property?

Because this is a question that seems to engender different answers, I asked this question through SurveyMonkey:

If the subject property is a solid Q5 or Q4 production house, but the owners have installed a new high quality kitchen and bathrooms, does the quality rating change?

Figure about a 10-year old house and all sales were built the same initially.

 

I purposely limited the responses to three choices because I did not want to get too many options, or otherwise there would be little consensus from the respondents. The choices included 1) that recently installed new high-quality kitchen and bathroom changed the quality, 2) that it did not change the quality but changed condition, and 3) that it did not change quality but was addressed as a line item adjustment. At this writing, there were 442 responses, which is more than sufficient to have a good sense of appraiser’s opinions.

442

20.36% of the respondents considered it an upgrade of quality

54.52% considered it a condition rating change

25.11% considered it a line item adjustment

In essence, 79% of the respondents considered it did not change quality but was either a condition change, or warranted a separate line-item adjustment.

So, what is the answer?

Strictly speaking, the UAD language indicates it is a change of quality, but in the minds of appraisers and/or users, is it? If “once a manufactured home, always a manufactured home” is true, how does swapping out a higher quality kitchen and/or bathroom from stock raise the quality of the whole house? How does changing a kitchen and bathrooms affect the structure of the house? Does it do anything other than change condition? If it is condition, how is this different than installing a new kitchen and bathrooms of stock quality in the stock quality house? Would it be best addressed as a condition item, but also as a line item because one aspect of the house is now atypical for the quality of the typical house by this production builder?

I do not have the answers, throw this out for discussion, because as proposed at the beginning of this article, the UAD ratings are too vague, and open to interpretation. Perhaps now is the time to drill down to what is truly expected within the various ratings and start a discussion on how upgrades to some non-structural elements to a house could, or could not, affect the overall quality rating of the building. Hopefully this brief article spurs on discussion of these ratings, and helps ferment more consistency between appraisers who do mortgage related work, since we are all judged by the actions of our peers in our market and we want to be judged fairly.

As in all things appraisal, when in doubt, disclose. Write more, explain more. It certainly helps mitigate those grey areas to inform the intended users why one condition or quality rating was chosen over the other options.

I have Google Earth and know how to use it

This post was originally published in Appraisal Today magazine and is republished with permission.

I have Google Earth and know how to use it

Seriously though, as a reviewer, it is one of the first tools I reach for when I look up the property that is the subject of the appraisal I am reviewing. Assume all reviewers do. We use it to make sure that the property does not back up to, side against, or face some type of externality such as a major 8-lane freeway, massive shopping mall or toxic waste facility. Hopefully the appraisal that has one of these externalities addresses it. Sometimes the appraisals go to great length to discuss externalities and any effect on marketability and value. Sometimes there is a sentence or two. Sometimes crickets.

Yesterday I pulled up GE on the house that was the subject of an appraisal I was reviewing and it backed up to a bunch of buildings. Looked possibly to be a school, but the street view maps took me around the side and to the entrance of what turned out to be a large condominium complex. Absolutely no big deal, but there wasn’t one single word related to this in the appraisal. I asked a group of appraisers whether they would make a comment if their subject property backed up to a condominium complex, and the responses ran the gamut from “of course”, to “no way, it is already covered in the neighborhood check boxes”.

While the check boxes for the neighborhood include multi-family, they do not include condominium, and in this instance, there was nothing in the appraisal even hinting that there was a mixture of single-unit uses in the area. This property didn’t raise a red-flag insomuch as backing to a freeway, commercial shopping center or toxic waste facility, but it did raise a question and warranted a bit more research. This is fine as it part of my job, but as someone who actually reads the reports in front of me, I was just left confused as to why it wasn’t even mentioned. I was even more confused by why so many appraisers say that it is not worth mentioning.

Maybe it is being old fashioned, but I grew up with the understanding that an appraiser was the eyes and the ears of the client, and that anything that would likely raise a question for the client should be addressed. Of course the freeway, mall and toxic waste facility are givens, but wouldn’t anything that was literally in the backyard also be something that would get questioned? How many minutes does it take out of the process to write a few sentences about a condominium complex? Couldn’t it be as simple as saying “The subject backs up to the XYZ condominium complex and has a seasonal view of some of these buildings. There is no negative effect on marketability or value of the subject property related to its location adjacent to this residential use” or some such rot?

While it is easy to overlook potential concerns due to the amount of reporting we have to do (and remember, there is no such thing as a perfect appraisal), stepping into the mind of the client and asking yourself “what would the client be concerned about” is a very useful exercise. While the client may not care about the house backing to a condominium complex because it is a residential use like the subject, they may care about it backing to the complex if for some reason it does affect marketability and/or value. It is up to us, as appraisers, to report and analyze what it is we see, and although we can never catch every little thing, our value is partly measured by our ability to communicate and to analyze these nuances.

Remember, reviewers have Google Earth and other tools at their fingertips, and most use them.

CU and Me: Let’s Be Practical For A Moment -Part 2

February 13, 2015

Editorial by Woody Fincham, SRA 

woody CU

Over the next several days I will be posting up my thoughts on the recent Fannie Mae Lender Letter Lender Letter  LL-2015-02.  This is part 2.  Part 1 is here.  

So let us dive in to looking at that Lender Letter.  Each of the quoted sections comes from the Lender Letter, which is cited above this. Following each are my thoughts on the quoted section.

“CU does not accept or reject appraisal reports or characterize an appraisal as “good” or “bad.” The CU risk score and messages pertain to risk and identify potential defects in the appraisal report. The lender is not obligated to “clear” or “override” the CU messages. The messages are meant to be used as red flag messages that lenders should use to assist with their appraisal analysis and inform their decisions based on a complete analysis and understanding of the appraisal report.[1]

I think this clarifies some of the biggest concerns to what CU is and is not.  Most large lenders and appraisal management companies (AMCs) have been using all sorts of third-party review rule sets and data pools for many years.  So this is nothing new under the sun. It really is the first time they are pulling in data that is verified by appraisers.  It has the potential to be a good thing, but it could very well be a bad thing.  It will depend on how the lenders use it in their respective review processes.  It is certainly bad for appraisers if they approach it the same way that they approached the 15% and 25% adjustment guidelines. I will not get into the old adjustment guidelines to deeply yet, but we all know that many lenders were set in stone about the 15% and 25% guidelines when Fannie Mae was not.  Yet lenders and AMCs still required adherence to those guidelines in some cases as hard and fast rules.

Working in a market as I do in Charlottesville, VA I understand where some concern would come from in the appraisal community.  Much of my personal work involves complex residential assignments.  From what I gather from those I have spoken to at Fannie Mae, and what information I have read about CU, I imagine many of my reports will become a four or five in their system.  I deal with properties that require regional research because they are status homes: essentially unique and custom to the market.  I would assume that these types of properties represent less than 5% of that MSA, and transfer infrequently.  The market is also small on the urban-side and voluminous in the rural and transition from suburban to rural type properties; acreage varies greatly.  The fact the MSA is in the Appalachian Mountains and that Fannie Mae requires segregation of finished basements from above grade living area; an overwhelming number of homes are built on slopes that have basements. I think you see that unless I am in a planned neighborhood or condominium development, it is unlikely my work product can be seen as conforming.  By circumstance, these properties will rate high in risk.

If I felt like my ability to perform work would be affected by the CU rick scores, then I would be up in arms as well.  Many of my colleagues believe that the CU risk score will affect them.  While I cannot say that it will (or will not), if AMCs/lenders decide to use the information to benchmark appraiser quality it could be a nightmare for some appraisers.  When you get to my thoughts on the 15% and 25% adjustment guidelines, later in this piece you will see more of my perspective on this.  I could be wrong, but I am not going to be overly concerned… yet. Until I see things happen contrary to Fannie Mae’s stated position, I will defer on an alarmist attitude.

“CU does not provide an estimate of value to the lender. CU provides a numerical risk score from 1.0 to 5.0, with one indicating the lowest risk and five indicating the highest risk. Risk flags and messages identify risk factors and specific aspects of the appraisal that may require further attention.”

I know many appraisers were convinced that this was not the case.  Many were positive that Fannie Mae was going to assign scores to the individual appraisers.  It is easy to see why that would be a concern, as the last major Fannie Mae policy change dealt with the Uniform Appraisal Dataset (UAD).  Appraisers are directly monitored on consistency of data for comparables with the UAD, but not with CU.

It is easy to mix it all up.  If you submit data in violation to their UAD standards, that does affect you.  The CU rating score does not.  It is relative to the report itself, not to the appraiser. With that stated, AMCs and lenders COULD use consistent high-risk scores on reports as a means to stratify appraisers as problematic from those that get lower ratings.  If this type of comparison was made a tracked, it could affect me.  I do not compete with the typical mortgage-use appraisers in my market.  Plenty stay in homogenous subdivisions and I cannot do the work that they do at the price points they do them.  If their resulting reports are lower-risk scores by the nature of the conformity these properties present versus the types of properties that I typically work with, I will be seen as an inferior appraiser.  Fannie Mae may state their position on such things but that does not mean the lenders and AMCs will not distill and extend the information they see further.

This is getting into the realm of conjecture; as such, there is not a whole lot of merit to it at all.  It does make one stop and ask questions though. I try not to worry about things that I cannot control so I will leave such thoughts alone for now.  But I will come back to the way lenders took the 15% and 25% adjustment guidelines out of context and altered the profession. I will have some more on that later, of course.

“CU’s selection of comparable sales considers the relevance of each potential comparable sale based on physical similarity, time, and distance. The selection process is not based on the relative “risk” or sale price of a comparable sale nor is there a “lower is best” approach. In fact, CU may assign a high risk score to an appraisal when the model identifies alternative sales that are potentially more relevant than the comparable sales used by the appraiser, regardless of whether the alternative sales are higher or lower in price.”

This certainly is concerning for appraisers.  Appraisers are paid to perform the research and when we do it, we can get defensive about someone questioning it.  Call it professional pride, but this can be a catalyst to incite negativity among us quickly. It is probably a good idea that appraisers write their reports with the above in mind.  Part of this may be addressed by including commentary regarding ideal and typical improvements for the shared competing market.

Since the risk flags are triggered by not using properties that are more similar on paper, commentary may need to change to deal with these items in mind.  Canned commentary certainly will not work in many situations. I know this means taking the time to write custom commentary in every report, but with enough foresight, it is easy enough to build a template that is set up as a skeleton to which specific report comments can be added. I have also suggested to a few colleagues, when asked, that they approach this similar to ERC (employee relocation) reporting.  Possibly embedding a chart of all the comparables surveyed from MLS prior to distilling then down to the comparables in the actual report. I realize this is more work, but if we start seeing lots of kickbacks on this issue, this might be a way to avoid it.

The way CU is setup, at least how it has been explained thus far, is that data is stratified by census block groups (CBG), which goes into the next quote…

“CU takes location into account using Census Block Group levels, which are subsets of Census Tracts. This is the most viable proxy for location in the absence of standardized neighborhood definitions, and more effective than use of arbitrary distance guidelines. Fannie Mae is not suggesting that appraisers use Census Block Groups to define comparable search areas, but appraisers remain responsible for indicating when comparables are from outside of the subject neighborhood and for addressing any differences.”

This has caused quite the banter in social media appraisal groups and pages. There are all kinds of issues with this concept.  The most obvious one is that appraisers do not stratify by CBGs normally.  It would be great if the software companies could create or add a way to also tag which CBGs each comparable comes from or address it in the rules set reviewer in each of the form packages.  This would at least allow a streamlined tool to allow the appraisers to comment on this item.  Perhaps even a data point that could appear in MLS data.  Most addresses are geo-coded now, so it would be an assumingly easy thing to do by over laying the CBG maps to existing maps.

Obviously, Fannie Mae chose this methodology because neighborhoods will vary market to market.  My concern with it comes from the staff reviewers at lenders and AMCs (Quality Control or QC Staff) that are not familiar geographically (geo competency) with the area. This certainly gets back to USPAP regarding writing the report at level commensurate to the intended users.  Explain away would the obvious answer, but that also require the readers and QC Staff to read the reports thoroughly.  I often hear from folks involved in QC review that they prefer cogent writing and brevity.  From some of the reviews I have personally gotten from lower-level QC staff (unlicensed appraisers); it seems many struggle with common terms in real property economics.  I struggle with dealing with those that gloss over when I use terms such as linkage, commercial zones, obsolescence, etc.

This also still sets up the appraisers to deal with non-appraisers applying arbitrary guidelines.  While distance guidelines are now going to be relaxed, in their stead I dread the likely possibility that QC Staff will want CBG differences addressed.  A bit later, I will address the sun setting of the 15% and 25% adjustment guidelines, but one has to see the possible pitfalls with CBGs that the lender-leveraged adjustment guidelines created.  QC staffs need to be well trained to deal with this.  Nothing prevents individual lenders and AMCs from requiring more than Fannie Mae’s suggestion as to how to implement the CU into their work processes.

“The risk analysis performed by CU is for exclusive use by the lender in their analysis of the appraisal report. After completing a thorough review, a lender should be able to have constructive dialogue with the appraiser to resolve specific appraisal questions or concerns. Although the lender may use output from Collateral Underwriter to inform its dialogue with appraisal management companies and appraisers regarding appraisals they supplied, the CU license terms prohibit providing these entities with copies or displays of Fannie Mae reports that contain CU findings, including without limitation the CU Print Report, the UCDP Submission Summary Report, or any other CU report. The lender must not make demands or provide instructions to the appraiser based solely on automated feedback. Also, the CU license terms prohibit using it “in a manner that interferes with the independent judgment of an appraiser.” Fannie Mae expects the lender to use human due diligence in combination with the CU feedback, and will actively follow up with lenders who are reported to be asking appraisers to change their reports based on CU feedback without any further due diligence.”

Fannie Mae is pretty clear the impetus is not to strong-arm appraisers with the feedback and analysis done by the system.  There is a real desire to keep human beings in the mix from Fannie Mae’s side.  The possible disconnect I see will be on the competency of the QC Staff.  The way many AMCs and lenders approach QC reviews is by hiring unlicensed staff people and expecting them to understand what valuation professionals do. Each appraisal is different and finding comments buried in a 20-50 page report is arduous at best; I can struggle with it and I have performed hundreds if not well over a thousand reviews in my career. The tactic that most QC staff uses now is simply kick to out a report because they cannot find a comment, or how the appraiser addresses the issues up front, and rely on the appraiser to point it out.  There are already copious examples of appraisers stating they are often already addressed in the original report.  Unless there is some reengineering of the process, this will only get worse as now the QC Staffs will be armed with more data.

One thing that we have already seen from CU is the copying CU comments being sent to the appraisers.  I have seen several examples from colleagues where something was flagged in CU and no human review was done.  No dialogue was attempted between the QC staff and the affected appraiser.  Fannie Mae has made it clear that the CU scores and flags are meant to be dealt with by QC staff actually having dialogue with the appraiser.  Instead, what we are seeing so far is many QC Staff people are simply copying and pasting CU comments and sending them as a standalone engagement for revision or commentary for the appraiser to deal with.  That is not creating dialogue; it is asking the appraiser to the work for the QC Staff.  One would think, after reading Fannie Mae’s letter that the expectation is for the QC Staff to check the report in question before calling on the appraiser to do anything.  If the appraiser has reasonably commented or dealt with the issues of concern, they should be good to go.

Much of this is going to remain an issue with AMCs and lenders that continue to utilize the services of uneducated and undertrained QC Staff.  Large lenders and AMCs that process lots of volume expect an awful lot of their QC Staff.  Each appraisal, if written well, is stand-alone research project. It should be read and understood with the same care it was prepared.  Pulling in someone that has never read an appraisal report as an hourly reviewer and expect them to get through the jargon and concepts that are summarized in a mortgage use report is counter-intuitive.  Either the Lenders or AMCs need to start hiring competent and credentialed valuation professionals, or spend the resources needed to train raw talent.  Both aspects are expensive, and neither is an option with the current compensation structures in the mortgage and valuation overlap of space.  We will certainly discuss fee levels in depth a bit later.

“Fannie Mae does not instruct or suggest to lenders that they ask the appraiser to address all or any of the 20 comparables that are provided by CU for most appraisals. It is also not Fannie Mae’s expectation that appraisals should contain only CU’s top-ranked comparable sales. In the majority of cases, there may be no material difference between comparable sales utilized by the appraiser and those identified by CU. Before asking the appraiser to consider any alternative sales, it is imperative that the lender analyze the relevance of the sale and determine if the use of such sale would result in any material change to the appraisal report. If the lender determines that there would be no material change, then they should not ask the appraiser to make revisions. Fannie Mae expects CU to enable lenders to accept appraisals “as is” with greater confidence.”     

The previous comments I have made are applicable here, too.  The disconnect lenders had, again the adjustment ratio guidelines come to mind immediately, understandably make appraisers wince at this idea.  The biggest concern, here again, is that QC Staff must be at a level of competency to understand that suggested comparable sales are just that, suggestions.  The way this was handled pre-CU was to send an appraiser comparable sales that were not used and ask the appraiser to then comment on not using them or to possibly also include them.  Of course, the comedy often ensues when the appraiser replies back that, “Two of the three comparables you sent me to consider are already in the report.”  This type of real world scenario proves that where Fannie Mae may need to concentrate some of this reengineering of the process is on those that do review and QC work.

Not to plug the Appraisal Institute (AI), but this may be the very reason that the AI created the new review designations, AI-GRS and AI-RRS.  Review is a completely different animal than Standard-1 and Standard-2 reporting.  I understand that hiring such professionals is a higher cost, which means more cost to the consumer, but let us face it; you get what you pay for.  At the very least, if the lenders want to have a positive outcome from the QC side, it should be built around utilizing well-trained professionals and the review designations are a step in the right direction in my opinion.  And it really may not need to be at the consumer’s dime so much as maybe it should come from the lenders.  The last I looked the larger lenders have no problems posting profit reports.

I spoke with a chief appraiser with a major AMC last week.  He informed me that they have three levels of human reviewers.  The first level is a combination of using technology to flag potential issues and areas that may need more in depth analysis. If there is enough need to elevate it upwards, it is then looked at by a non-licensed staff person.   On the next and final level, a human being that is licensed is involved.  It is apparently an effective way to do things, but even their internal processes still leave some room for improvement.  When so much volume is handled by any given entity, and cost is always the biggest concern, it is impossible to hire but so much real talent.      I will come back to cost a little later when I discuss fees and compensation.

End of part 2.

Stay tuned more to come over the next week. If you have any suggestions or want to share some war stories, please send them over to woody@woodyfincham.com.

[1] “Lender Letter  LL-2015-02,” Fannie Mae, https://www.fanniemae.com/content/announcement/ll1502.pdf (February 2015)

Highest and Best Use is More Than Just a Check Box

This originally appeared over the Appraisal Buzz on Wednesday, December 3, 2014

http://appraisalbuzz.com/buzz/features/highest-and-best-use-is-more-than-just-a-check-box

As review appraisers, one of the issues that we see all the time is the failure to analyze highest and best use for a market value opinion related to mortgage lending appraisals. This makes sense to a large degree, because many appraisers believe that providing the “yes” answer relieves them of further analysis and communication. We wanted to address this topic and offer some insight as to why one may want to rethink their approach to this common issue. In that light, we thought that we would look at a key part of the valuation process, but one that often gets overlooked in residential reporting: Highest and Best Use. With the majority of reports being written on pre-formatted reports from Fannie Mae, many appraisers skip over this section as nothing but a box to check.

A required characteristic of any valuation professional is the ability to learn, and not just occasionally, but to continuously do so through one’s career. Look at any successful appraiser that you know; chances are that he or she makes time for classes. Many of the leaders in the profession are even known to write course work or review it for publication. So do not look at this article as us telling you that the sky is falling, but rather as a perspective that many of us have adopted in our evolution as valuation professionals. I know that we both will periodically look back at past work and reevaluate how we approached a specific problem. After all, as we learn and experience more, we learn new ways to do things or ways to improve upon what we already do. The goal is continual improvement.

As appraisers, we are by nature opinionated. We have a tendency to believe our way is the only way, or the best way, and although we may expect perfection, none of us come into the world knowing how to appraise. Appraisal learning is life-long, and perfection is not possible, although we strive for it by continuing to have an open mind to gaining new insights. The Uniform Standards of Professional Appraisal Practice (USPAP) even addresses that perfection is impossible to attain, and competence does not require perfection.1 The Standard Rule 1-1 (a) comment also addresses how the principle-of-change it continues to affect the way that appraisers perform their work.2 These items are under the development standard with which we all abide, and are the set up the point we are making – which is that none of us are perfect, and hopefully we all simply try and improve our skillset, each and every day.

The Valuation Process is an eight-step procedure that starts with the identification of the problem to solve; flows on to the determination of the appraiser’s scope of work; data collection and property description; followed by data analysis (see figure 1). Data analysis includes the market analysis as well as the Highest and Best Use Analysis – considering the land as vacant; what the ideal improvement would be, and the property as currently improved. Next, is the land value opinion; application of the approaches to value; reconciliation of the valuation approaches as well as a final opinion of value followed by the reporting of that defined value.

Clearly, the data analysis section requires a highest and best use analysis related to a market value opinion. This is also succinctly addressed in The Appraisal of Real Estate, 14th Edition on pages 42-43 for further reading.3

Figure 1: Courtesy of the Appraisal Institute (used with permission)

The 1004 form, which is the most common report form for residential mortgage assignments, specifically asks the question “is the highest and best use of the subject property as improved (or as proposed per plans and specifications) the present use?” followed by a check box for yes or no, and if no to describe (see figure 2).

Figure 2

4

As Standard 1-3 (b) in USPAP exhorts us to develop an opinion of highest and best use of the real estate when a market value opinion is developed (page U-19 2014-2015 USPAP), and Standard 2-2(a)(x) states specifically “when an opinion of highest and best use was developed by the appraiser, summarize the support and rationale for that opinion” (page U-24 2014-15 USPAP), checking the box without any further discussion is not adequate. Perhaps it is the lack of description in the box next to “yes” that throws appraisers off, but USPAP is clear that when it is developed, a summary for the opinion is required.5

To even start to address Highest and Best Use, the appraiser needs to have at least visited the zoning ordinance to not only understand what is an allowable use, but also what the minimum site size requirements are; what width is required; what the setbacks are, etc. Often we see zoning mislabeled, and more often than not, no information about what even the minimum site size is for the use. Without this basic information, it is not possible to start analyzing the highest and best use.

Discussing this issue with some appraisers online it was apparent that many do not believe any additional summation is required in the form other than checking the yes box, with the argument that as zoning is reported as either legal or not, meets the legally permissible criteria. That a house is built (or proposed) tests the physically possible criteria, and that reporting of functional depreciation in the cost approach or sales comparison approach addresses overall conformity and therefore financial feasibility, and that finally the remaining economic life provides for highest and best use as currently improved. While this may seem like a reasonable argument, we do not believe it is sufficient for a number of reasons, including it being nothing but an executive summary of real work and does not rise to the level of summation.

In addition, when doing work for a lender client, one must ask, “What is the purpose of this report?” The obvious answer is to determine market value, but the lender uses it as a risk assessment tool. They are trying to ascertain if the property is atypical to the market in any way and if so, how does that affect the value, and ultimately the ability to free them of the collateral in the event the loan goes sour. While an appraisal cannot answer that question in the entirety, it does help them assess their full risk by lending on a specific property.

Since the majority of appraisal work related to mortgage lending completed on form reports is for an improved property, much of the time the conclusion is that the highest and best use of the real property is that which is already in place. How difficult is it to flesh out a short paragraph related to this analysis? Given what we are seeing on a routine basis, it is apparently a monumentally difficult task given that it is rare for us to see anything beyond the “yes” check box.

What we are suggesting is that appraisers take a few extra minutes to summarize the highest and best use analysis. It can be done in as little as a sentence, but usually no more than a paragraph. One of the biggest reasons that we suggest it is that it will force you to slow down and look at your data. There have been instances where one of the authors has found out that some appraisals under review were in an illegal or a legal non-conforming use. During the review, it was discovered that the appraiser did not stop and do the analysis or did not really understand that they should look at it or report it. This puts a lender in a sticky position as they may have to shelf the loan and will not be able to sell it on the secondary or worse, have to buy it back.

In such instances, it may require several pages to support the highest and best use. Once it becomes something more complex, due diligence is paramount. The biggest reason appraisers should care about this is that it puts the appraiser in a more defensible position if something awry happens down the road with the loan. By attempting to address this directly up front you are less likely to be discredited for skipping or going too quickly through a section of the report.

One of the authors has done litigation review work where this specific issue was used by the attorneys as part of their strategy to discredit the appraisal report. In litigation, attorneys will often go to the fundamentals to challenge the appraiser’s work. To a judge or a jury it easy to make the connection that if the report is short on a fundamental concept then it is easy to assume it is also short on the section most scrutinize the heaviest, the sales comparison approach. We have both seen reports that have great sales comparison approaches, but little else in the way of a well-written report. Those are the reports that can hurt you in situations where you must defend your work.

So there you have it folks. A seemingly simple thing that really is not so simple. If anything, we hope this offers you something to think about when you are writing your reports and developing the analysis. We are sure this will create some interesting comments as well. Please feel free to share your thoughts as discourse helps us all learn more.

– See more at: http://appraisalbuzz.com/buzz/features/highest-and-best-use-is-more-than-just-a-check-box#sthash.kXUgU1Qb.dpuf

Thrilling? You Bet! Part 3-Final Part

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OK, so what does the Cost approach tell appraisers (at least, those who are willing to listen) about the market? The listening is in the analytics.

Consider, first of all, the site value as if vacant. This is a separate appraisal within the appraisal. If the appraiser does not know to a professional certainty the value of the subject site as if vacant, how can that appraiser adjust the comparable sites (as if vacant) to it? It is ironic that, to adjust the comparable site’s value to that of the subject, the appraiser must know, to the same certainty, the value of the comparable site as if vacant, too. Assuming three comps and a listing, then the appraiser goes thru this site-as-if-vacant analysis five (5) times. If the appraiser is listening, an analysis five (5) sites deep will tell the appraiser an abundance about a market.

Now, consider the entrepreneurial incentive/profit aspect of the analytics of the Cost approach.

Too many appraisers have fallen into the trap of saying there is not such a profit or incentive in the cost approach since the sale of the property is from one retail buyer to another. It is not a sale from a builder/developer to a retail buyer. This is true. It is true, yet it is also thunderously irrelevant. An appraiser builds the house new on paper. Don’t new houses sell (hopefully!) at a profit from the developer/builder to a retail user? Since it is physically impossible to construct a used house, the analytics of the Cost approach assume a new house first. Therefore to estimate the reproduction or replacement cost new of a house and not include an entrepreneurial incentive or profit is to fail to take a step the market commonly takes. How reflective of the market is that?

For grins and giggles, assume a 15% entrepreneurial incentive to the cost new before any depreciation. This is a trail balloon the appraiser floats to see if there is such a reward in the market. If the market will not pay such a reward there is, by definition, an external obsolescence factor in the market. This is a market condition which the appraiser has an obligation to describe within the report.   Yet, if the appraiser is not willing to measure the market to see if such a reward is present, how can s/he report it? The analytics of the Cost approach show if such a reward is present. The analytics of the Sales Comparison approach do not and cannot.

A blog such as this one is not the time or place to present a long article on calculating depreciation. The point is that while FannieMae, et al, no longer require a Cost approach to be part of an appraisal report going to them, whoever said the analytics of the Cost approach should not be part of an appraisal? FannieMae surely did not. How can an appraiser listen to, and then interpret the market, if s/he ignores two-thirds (Cost and Income approaches) of what it says?

Thrilling? You Bet! Part 1

TA article 1

A lot of appraisers were thrilled when FannieMae, et al made their great announcement. Which great announcement? FannieMae publishes announcements all the time. It was when they announced they would no longer require the Cost approach to be part of an appraisal.

Hooray, a real time saver! Thank you FannieMae et al! The Cost approach is a waste of time anyway! Nobody understands accrued depreciation. Even builders cannot decide on what’s a hard cost, a soft cost, and overhead. And that entrepreneurial profit/incentive thing! What difference do they make anyhow?! The house is up and built! People don’t expect an entrepreneurial profit/incentive when they sell their house, so why have to worry about it in an appraisal!? Give me three recent sales in the same neighborhood, and I’m in and out of that appraisal in no more than four hours! Cha-ching! That’s how I can put some money in the bank! Besides, I always back into the Cost approach from the Sales Comparison approach!

Perhaps, there is another facet of the issue to consider?

It’s true “the market” does not typically does not use the Cost approach to buy and sell houses. It’s also true we appraisers enshrine the market and its trends. That’s what we do. So, if we enshrine the market, why are we willing to ignore what it tells us? But, how do we ignore it if that’s not how the market trades houses? Simple. True, the Cost approach may not talk to us in a transcendent baritone. It more likely advises us sotto voce. We listen when the market “talks” to us. Why are we less disposed to accept its advice when it merely whispers? Lovers whisper; antagonists SHOUT.

So, how does the Cost approach whisper the market’s trends to us? There are at least two ways it communicates market trends to us, if we will but listen.

The first is thru accrued depreciation. Many appraisers take accrued depreciation from published depreciation tables. There is no question these are mathematically correct. However, these tables assume residential housing wears out at a more-or-less curvilinear rate. That rate indicates little depreciation per year when a property is new, then more per year as it ages. This, too, is true. These tables, however, do not and cannot account for incredibly hot markets, or dead ones. What do these mean?

An incredibly hot market may see the man-made improvements to a site actually appreciate in value. Yes, this is a function of speculation. A speculative market is not one that meets the definition of market value. Yet they exist and we have to interpret them. The published tables do not reflect this market condition, so we have to.

Next, to consider is that dead market. Prices have fallen faster than a Senator’s job-efficiency ratings. Our broker friends tell us the properties are selling for little more than land value. Again, the published tables do not and cannot reflect this situation.

In other words, the published tables are at their most accurate in a flat market. How many of those have you seen in the last 10-years?

Appraising The Right Way Part 1: Requiem for a Dream

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We are two appraisers separated by a three- hour flight or a nine-hour car ride.  We have never met in person, but have come to know one another through social media.  We are designated and recognized experts in residential valuation in our respective regions; both have had successful careers working in various positions within the profession; we are separated by enough distance that we experience completely different market stimuli.  We subscribe to doing valuation work the right way.  The way it should be done: defensible and well supported. Yet, we (and many others in the profession) are watching it being dismantled by the lenders, appraisal management companies (AMCs) and even from within the profession itself.  This is not the way that it should be, yet we still stick to our guns and we dream about how it should be regardless of the present reality.

We share a dream:

Like any great dream, it is lofty, challenging and worthwhile. We dream that we can make a living as fee appraisers, doing our jobs the proper way. The dream is to take the time to analyze the problem to be solved; research the market thoroughly including market trends; interview the market participants; analyze the sales and extract market adjustments; and then report  the opinion of value  in a way that the client can understand the  thought processes. Within this, there will be good support for conclusions and the appraisal will make complete sense to the reader. It will not leave gaping holes or questions. The opinion of value will be well supported by sales that are both inferior to the subject as well as those that are superior (and ideally equal). The appraisal will address the current market conditions and the active competition as well as the closed and pending sales.

Analysis is what we do, refined by the appraisal process, tempered by ethics and integrity all rounded out by participation in a profession that is carried out by like-mined and well-intentioned practitioners.

The dream continues:

Our clients  will truly care about the analysis and it will be meaningful to them. They need something of substance, and not simply paper for a loan closing package, or simply a report for a divorce or bankruptcy proceeding. The client understands that the valuation is based on fact, but in the end is an educated and well-supported opinion. The client understands that each report is a unique and extensive research project that is custom designed. The client is comfortable with the opinion of value because they reached out to a well-qualified and experienced appraiser; one that is rewarded the report because they are respected professionals, not just another step in a loan closing process or the cheapest one they could find.

Prologue:

We realize this is getting into the lofty and idealist side of things, hence the title of the blog.  What this series is going to focus on is some of the challenges appraisers face, and how we should handle them.  There is constant pressure on appraisers to adhere to scope of work enhancements from clients.  While we may mention customary and reasonable fees and the dynamic that the cost of business plays in the appraisal process in the course of this series, this is about what appraisers should be doing after they accept an assignment.

Rachel has years of experience reviewing appraisal reports working within the lending world as a staff reviewer and manager, and in the fee world through her private practice. Rachel has recently earned the new residential review designation with the Appraisal Institute.  Woody has been doing private fee review work for years and also has to review reports for tax assessment appeal as part of his position within the assessor’s office in Albemarle County, VA.  Between our combined experiences, we will focus on some issues that we see pop up repeatedly throughout various reports that have made their way across our respective desks over the years. 

RIP Appraisal Advisor

By Woody Fincham, SRA

Reprinted from Appriasl Buzz

It is with a good deal of lament that I am writing this post. I opened my email this morning to see an announcement from Appraisal Advisor (AA) stating that they that would be ceasing operation as of February 1, 2014. For those that did not know about them, they were, to my knowledge, the only source for appraisers to post reviews about working with Appraisal Management Companies (AMCs). AA also developed credit ratings based on appraiser reviews of working with each rated AMC. Appraisal Advisor was truly a tool that was of great use to me and many other appraisers that worked with the AMCs.

This tale is common in the appraisal profession. Appraisers can be a testy lot to deal with, even more so when they are asked to pay for anything. I am an appraiser, and I get that money is tight in the profession. My comment is not an admonishment to appraisers, but rather a fact. In this case, I see where the thousands of appraisers have signed up but have failed to participate. Matthew Biggers, Co-Founder of AA, wrote in his announcement of the forthcoming shut down:

“Unfortunately, the lifeblood of Appraisal Advisor – appraisers submitting client reviews – fell prey to the age-old “80/20” rule. Over 79% of our many thousands of ASC-verified appraiser members submitted zero reviews, while only 3% submitted more than five reviews.

That was far below what we needed to support a revenue model of non-appraisers paying to access and advertise on the site. And since appraisers had already spoken loudly that they wouldn’t pay directly for it either, that cut off the only two sources of funding for Appraisal Advisor (Biggers, 2014).”

I wish it were not so, but we must bid adieu to yet another concept that is designed to help the profession at large; mostly, as a group, we cannot see the forest for the trees. The AMCs won out here at the expense of residential appraisers. Matt did share some interesting information about a yet unnamed AMC that was very pleased to know that AA was going off line. If I ever get a chance to update this blog with that information, I will share the relevant information pertaining to it. I am sure many AMCs will be happy to see that as well because the less transparency between independent professionals means more fracturing. More fracturing means more leverage for the AMCs.

Thanks for Trying Mr. Biggers!!

Works Cited
Biggers, M. (2014, January 21). Important announcement about Appraisal Advisor; Email. Atlanta, GA, USA.

– See more at: http://www.appraisalbuzz.com/buzz/blog/2014/01/21/rip-appraisal-advisor#sthash.HMidn7gu.dpuf