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Uniform standards of professional appraisal practice: implications for the financial community.

Appraisal reform, as the term is currently used, is of recent origin. In fact, changes occurring now in appraisal compliance and financial institution review are primarily the direct result of events since 1985. Of particular interest is the common thread of uniform appraisal standards that runs through current appraisal reform as well as federal and state appraisal compliance. Clearly, the intent of both private and public involvement in appraisal reform has been to establish, adopt, and implement a set of minimum appraisal standards that could establish the criteria under which appraisal assignments and appraisal reports would be conducted. While some historical events have clearly influenced the development of the appraisal profession, the most significant changes have occurred within the past seven years.

Professional appraisal organizations have been in existence for many years; however, membership in these organizations historically has comprised only a small percentage of practicing real estate appraisers. This was most attributable to the fact that in the past, most states merely required an appraiser to have a pulse and a business card. While this is not entirely true, the point is that with the exception of a few states that required a real estate broker's or salesperson's license to appraise real estate, little else was required. In short, the masses of practicing appraisers were not affiliated with professional appraisal organizations. Appraisers who did affiliate with a professional organization were typically full-time appraisers who wanted to improve their expertise through membership in an organization that offered education, seminars, and professional designations. Professional designations implied that an appraiser was interested in improving his or her skills and knowledge. Thus appraisal organizations offered educational programs to their members and encouraged their participation.

As the number of appraisal organizations grew, increased economic activity caused the demand for appraisal services to escalate. Land development projects, office complexes, and retail space continued to be developed. Some financial institutions were eager to back such development. In addition a government attitude leading to less federal regulation resulted in what have since been perceived as poor underwriting standards and guidelines by financial institutions. Sloppy and hurried underwriting made for bad loan decisions. Pressure on appraisers to "make the numbers work" caused the analyses, opinions, and conclusions of some appraisers to be something less than professionalism demanded.

HISTORICAL DEVELOPMENT

Private efforts

In 1985, few people recognized what have since become the infamous names of real estate developers and financial institutions who took large losses on real estate projects. During this time, however, regulators became aware that troubled real estate loans were becoming a pervasive national problem. The most significant regulatory event of 1985 with respect to real estate was the issuance of the Office of the Comptroller of the Currency's (OCC) Guidelines for Troubled Real Estate Loans on October 30, 1985. Declining values and rising vacancies in certain markets nationwide were noted in these guidelines.

A significant event occurred in the private sector during 1986 that laid the foundation for the uniform appraisal standards in use today. Eight leading professional appraisal organizations in the United States,(1) along with the Appraisal Institute of Canada, formed the Ad Hoc Committee on Uniform Standards of Professional Appraisal Practice. Patterned after the accounting profession, especially the Financial Accounting Standards Board, these organizations formed a set of standards that were to become recognized as the "generally accepted appraisal standards."

In 1987, the eight U.S. professional organizations that had formed the Ad Hoc Committee established a nonprofit, educational corporation known as The Appraisal Foundation (TAF). The stated purpose of TAF is "to foster professionalism by helping to ensure that appraisers are qualified to offer theft services and by promoting the Uniform Standards of Professional Appraisal Practice."(2) The intent of TAF was 1) to move toward minimum qualification criteria for real estate appraisers; and 2) to develop, improve, and promote a set of uniform standards that would be accepted in the marketplace as the accepted standards for the appraisal profession. The Uniform Standards of Professional Appraisal Practice (USPAP) became and are now recognized as the acceptable minimum standards for the appraisal profession.

Throughout 1988 and continuing into 1989, the role of TAF in the implementation of appraiser qualifications and appraisal standards increased in importance. To meet these concerns, TAF created two boards, the Appraiser Qualifications Board (AQB) and the Appraisal Standards Board (ASB).

The AQB was to work with the users of appraisal services, the states, and other regulators to ensure that certified appraisers possessed the educational background and the experience necessary to perform their functions in a professional manner. The AQB became the source relied on by the Appraisal Subcommittee of the Federal Financial Institutions Examination Council (FFIEC) in setting education, experience, and examination criteria for the states in certifying and licensing appraisers.

The ASB was created to promote acceptance and implementation of the USPAP. In addition, the ASB was expected to keep the USPAP current to address changes within the profession.

Early federal legislation and regulatory efforts

As a result of continuing problem loans and public awareness of trouble within certain financial institutions, Congressional action became part of the reform movement in 1987. Congressman Douglas Barnard (D-Georgia), chair of the Commerce, Consumer and Monetary Affairs Subcommittee of the House Government Operations Committee, began holding public hearings to deal with troubled financial institutions and possible solutions. Those hearings culminated with the Barnard Bill (H.R. 3675), introduced November 20, 1987. The purpose of the legislation was "protecting the financial and public policy interest of the United States in certain real estate-related financial transactions."(3) While it was an early attempt at appraisal reform, the legislation failed.

On July 10, 1987, the OCC issued its Guidelines for Troubled Real Estate Loans (known as the "1987 Guidelines" to differentiate it from the 1985 OCC guidelines with the same name). Its purpose was to further explain Examination Circular 234, issued in 1985.

The first comprehensive regulatory attempt to reform appraisal practice occurred on December 14, 1987, when the Board of Governors of the Federal Reserve System (FRS), the OCC, and the Federal Deposit Insurance Corporation (FDIC) issued a joint statement entitled Guidelines for Real Estate Appraisal Policies and Review Procedures (BL-40--87) (guidelines). Its purpose was to "remind bank boards of directors and management of the importance of sound real estate appraisal policies and procedures and reaffirm supervisory policies regarding acceptable appraisal practices."(4)

The guidelines stated that appraisal reports must "conform to the accepted and established professional standards of the nationally recognized professional appraisal organizations."(5) While specific reference was not made to the USPAP, which by this time had been adopted by TAF, the intent of the guidelines was obvious. The requirements contained in the guidelines concerning the contents of an appraisal report followed the appraisal process as covered in the USPAP. In general, the guidelines required 1) a written appraisal policy statement as part of the institution's overall lending policy; 2) acceptable standards regarding appraiser selection and qualifications/independence; and 3) an adequate review process.

The Office of Management and Budget (OMB) issued Circular A-129 on November 25, 1988. The circular, which extended to all federal agencies under OMB's jurisdiction, required the use of either state certified or state licensed (registered) appraisers after July 1, 1991. In addition to the agencies under OMB's jurisdiction, the regulation extended to the Federal Housing Administration, the Veterans Administration, and the Farmers Home Administration. To quote Circular A-129:

Agencies shall require that all appraisals be conducted at a minimum in accordance with generally accepted appraisal standards as reflected in the Uniform Standards of Professional Appraisal Practice as promulgated by the Appraisal Standards Board of The Appraisal Foundation.(6)

As a result of OMB Circular A-129, the regulatory intent was clear. Real estate appraisers would have to demonstrate competency through licensure and certification and would be expected to abide by a set of appraisal standards--specifically, the USPAP.

FIRREA and the FDIC Improvement Act

Many of the efforts of the private sector, the public sector, and the regulatory agencies culminated in the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) signed into law August 9, 1989. FIRREA specifically referred to the USPAP in Title XI, Section 1110, which stated:

Each federal financial institutions regulatory agency and the Resolution Trust Corporation shall prescribe appropriate standards for the performance of real estate appraisals in connection with federally related transactions under the jurisdiction of each such agency or instrumentality. These rules shall require at a minimum--

(1) That real estate appraisals be performed in accordance with generally accepted appraisal standards as evidenced by the appraisal standards promulgated by the Appraisal Standards Board of The Appraisal Foundation, and

(2) That such appraisals shall be written appraisals. Each such agency or instrumentality may require compliance with additional standards if it makes a determination in writing that such additional standards are required in order to properly carry out its statutory responsibilities.(7)

The question becomes: Pursuant to FIRREA, what is a federally related transaction? Section 1121 (4) of FIRREA defines a federally related transaction as "any real estate-related financial transaction which (a) a federal financial institution; regulatory agency or the Resolution Trust Corporation engages in, contracts for, or regulates; and (b) requires the services of an appraiser.(8)

Section 1121, however, does not specifically state which transactions do and do not require the use of an appraiser. Citing their authority under Section 1110, members of the Federal Financial Institutions Examination Council (FFIEC) stated in their final appraisal rules which transactions do and do not require an appraiser. In general, those that require the services of a state licensed or state certified appraiser are the ones with a transaction value of greater than $100,000 for the Federal Reserve System, the FDIC, the OCC, and the Resolution Trust Corporation (RTC). The Office of Thrift Supervision and the National Credit Union Administration currently require a state licensed or state certified appraisal when the transaction value is greater than $50,000.

Transaction value may apply to either financing or an acquisition situation. For financing, the transaction value is determined by the amount of a specific loan rather than the aggregate amount of debt on the property. For example, if a borrower owes $125,000 on a property and wants to borrow $10,000 on a second mortgage, such a loan is not a federally related transaction because the second

mortgage is not in excess of $50,000 or $100,000 depending on the regulatory agency involved. In an acquisition situation, transaction value is determined either by the acquisition price or the market value of the acquisition, depending on the federal financial regulatory agency involved. A real estate-related financial transaction is one that involves "(A) the sale, lease, purchase, investment in or exchange of real property, including interests in real property, or the financing thereof; (B) the refinancing of real property or interests in real property; and (C) the use of real property or interests in real property as security for a loan or investment, including mortgage-backed securities."(9) In essence, if a lender records a security interest against a real property right in excess of $50,000 or $100,000 (depending on the regulatory agency involved) the transaction is within the scope of FIRREA and thus is subject to the appraisal guidelines of the appropriate regulatory agency.(10)

The Federal Deposit Insurance Corporation Improvement Act of 1991 (PL 102-242) amended parts of Title XI of FIRREA.(11) Section 1119 of Title XI was amended by changing the effective date in paragraph (a)(1) to read "Not later than December 31, 1992." Section 1119 refers to the use of licensed or certified appraisers by financial institutions in federally related transactions. The original date was not later than July 1, 1991.(12) A state may implement its licensure/certification statute prior to the amended date (and many states have); however, every state must have had its licensing and certification program in place by December 31, 1992.

Section 472 of the Federal Deposit Insurance Corporation Improvement Act states that the Appraisal Subcommittee shall not set education and experience requirements in the licensing of appraisers. The intent of this legislation is to permit individual states to be free to set their own specific minimum requirements for licensed appraisers as opposed to the minimum requirements for certified appraisers that are set nationally.

Title 2, Section 223, Paragraph (d) of the act also affected lenders by requiring them to provide borrowers with copies of appraisal reports if borrowers make written requests for reports. The confidentiality section of the Ethics Provision of the USPAP requires appraisers to protect the confidential nature of the appraiser-client relationship. Accordingly, as explained in the comment section of the confidentiality section, an appraiser may disclose confidential factual data obtained from a client or the results of an assignment to three parties: 1) the client or persons specifically authorized by the client; 2) such third parties as may be authorized by due process of law; and 3) a professional peer review committee. Statement on Standard Number 5 (confidentiality rule) further expands the confidentiality section by allowing an appraiser to presume that information obtained from the client is not confidential unless the client specifically places the appraiser on notice that the information is confidential.(13) The act does not address an appraiser's responsibilities toward a borrower but only addresses the financial institution's responsibilities.

FUTURE DIRECTIONS FOR LENDERS

Each financial institution's applicable regulatory agency has written appraisal rules that require adherence to the USPAP.(14) In addition, each agency has extended its appraisal rules to cover two major areas of examiner concern: 1) appraiser disclosure/documentation; and 2) appraiser independence.

Appraiser disclosure/documentation

Financial regulatory agencies have addressed the issue of appraiser disclosure and documentation through their final appraisal rules that address the following 14 specific appraisal reporting points.

1. Compliance with USPAP(15) 2. Disclosure of competency 3. Market value 4. Written appraisals 5. Sales history 6. Revenues, expenses, and vacancies 7. Marketing period 8. Trend analysis 9. Deductions and discounts 10. Prohibited influences 11. Self-contained appraisals 12. Legal description 13. Personal property, fixtures, and intangible items 14. Use of recognized appraisal approaches

Several of the appraisal rules focus on appraiser disclosure and documentation. In addition to the disclosure and documentation requirements imposed by the USPAP, appraisers are required to report items for institution compliance purposes.

Compliance with USPAP

Of the minimum standards cited in the final rules, compliance with USPAP is the first minimum standard mentioned. Standard 1 addresses the appraisal process, while Standard 2 addresses the communication (documentation) of appraisal reports. The point to remember is that USPAP sets minimum requirements. For example, USPAP allows appraisers to have present or prospective interest in the property or bias with respect to the parties involved as long as it is disclosed. Regulatory agency final rules, however, prohibit any direct or indirect interest or bias.

Disclosure of competency

An appraiser is required to disclose lack of competency if he or she does not have the knowledge and experience to complete the assignment. An appraiser is required to disclose such lack of competency prior to accepting an assignment or entering into an agreement for appraisal services. If an appraiser lacks the competency necessary to complete an assignment, he or she should inform the financial institution. Such reporting allows the institution the opportunity to assess the problem and to decide whether to allow an appraiser to proceed with an assignment or to employ another appraiser. If an institution proceeds with an appraiser who is not initially competent, the appraiser must disclose lack of competency, take the necessary steps to become competent, and describe the steps taken in the appraisal report. The steps taken to become competent may include personal study, affiliation with an appraiser who is believed to be competent, or retention of others who are competent. To be competent, an appraiser must possess knowledge and experience of the property type being appraised and the geographic area involved.

Market value

A report should include an acceptable definition of market value. The definition should be the one included in the definitions of the USPAP unless, for example, a state statute has a different market value definition. If this is the case, the appraiser should cite the Jurisdictional Exception to the USPAP and use the definition from that state's statute.(16)

Written appraisals

A report should be written either in a narrative format or in an appropriate form chosen by the appraiser. The content rather than the form of a report is important. For single-family residential transactions, the vast majority of lenders use the Uniform Residential Appraisal Report (URAR). For income-producing property, lenders use either a narrative report or a form report--specifically, the Uniform Commercial and Industrial Appraisal Report (UCIAR). There are three versions of the UCIAR report: 1) the UCIAR-EP for existing properties; 2) the UCIAR-SP for small properties (e.g., those with a loan of $750,000 or less); and 3) the UCIAR-NP for new projects.

Sales history

At a minimum, an appraisal should conform to Standards Rule 1-5(b) of the USPAP. A report should state whether sales of the subject property have occurred over the past year for one- to four-family residential property or over the past three years for all other property types. If there have been prior sales within these minimum time periods, the appraiser should comment on and document them.

Revenues, expenses, and vacancies

If a subject property is income producing, the appraisal should report on current revenues, expenses, and vacancies. An appraiser should discuss historical rent levels in light of current market levels, how market rents relate to contract rents for the subject property, and the current state of market vacancies and expense levels.

Marketing

The marketing period is the amount of time required to sell the subject property in an open market and should be based on prior selling times of competitive properties. An appraiser must disclose the assumptions used in developing the estimate for marketing time.

Trend analysis

Market trends must be analyzed regardless of the direction of the trend. Identification of negative trends, such as higher rent concessions or declining sale prices, is of particular importance.

Deductions and discounts

An appraiser should report an "as is" market value. A market value estimate may be reported three different ways: 1) as is; 2) "subject to" (e.g., subject to a zoning change); or 3) "per plans and specifications" (e.g., what may occur when appraising new construction). An as is market value estimate is the value of the subject at a point in time, in its current condition, on the date of the value estimate.

Prohibited influences

In addition to the minimum certifications required by Standards Rule 2-3, an appraisal report should contain a statement that it was prepared on an independent basis. Further, the appraisal cannot be contingent on the reporting of a requested minimum valuation, a specific valuation figure, or the approval of a loan.

Self-contained appraisals

A report should be self-contained. Some appraisers use the phrase "based on this and other data in my files" in their reports. If other data in the files are relevant to a report, such data should be included in the report and should not be incorporated by reference. If the information is widely available, however, it does not need to be included. For example, zoning regulations need not be included because they are widely available.

Legal description

A report should include a complete legal description. The appraiser should not state "see deed" in the report. A copy of the description from the deed should be attached or included in an addendum to the report.(17)

Personal property, fixtures, and intangible items

If they affect the value of real property that is the subject of the report, items of personal property, fixtures, and intangible items should be shown separately in a report. In addition, an appraiser should comment on the contributory effects of such items.

Use of recognized appraisal approaches

A report should consider all three of the traditional approaches to value. If one or more approaches is not used, an appraiser should disclose why it was not used and discuss its significance to the problem. For example, if data were unavailable, the appraiser should state this fact and discuss the importance of the unavailable data. Finally, if material information was unavailable to an appraiser, this fact should be included in the report and the appraiser should discuss the impact of the unavailable information.

Appraiser independence

Appraiser independence is a second area of examiner concern. Allegations of lender coercion of appraisers have led to stringent appraiser independence requirements. One problem cited by regulators in the past was the pressure on appraisers to "get the right number." This alleged pressure led to several appraiser independence restrictions.

An appraiser must have neither a direct nor an indirect interest in the subject. A direct interest is one in which an appraiser has an interest, financial or otherwise, in the property that is the subject of a report. An indirect interest is one in which an appraiser owns property whose value is affected by the value of the subject, if the appraisal was the proximate cause of the effect.

Staff appraisers must not be supervised or controlled by someone in the lending, collecting, or underwriting areas of the financial institution. The goal of this restriction is to allow staff appraisers to remain independent as well as to promote objective value estimates.

In addition, Final Appraisal Rule 10 requires that a report contain a statement that the appraisal report was prepared on an independent basis and that the appraisal was not contingent on the reporting of a requested minimum valuation, a specific valuation, or the approval of a loan.

CONCLUSION

FIRREA has imposed new requirements on financial institutions and their compliance with the regulations of the appropriate regulatory agencies. At a minimum, appraisal reports must follow the USPAP and be in writing. The appraisal rules of the federal financial institutions regulatory agencies also require adherence to 14 specific report issues. The agencies have instituted additional appraisal rules, pursuant to their authority granted in Section 1110, Title XI of FIRREA, which focus on documentation/disclosure in the appraisal report and appraiser independence.

To the extent that appraisers will continue to be employed by financial institutions, appraisers must appreciate the implications of the USPAP on the financial community. The result of the regulations has been a significant increase in the minimum reporting requirements for appraisals performed as part of federally related transactions.

William B. Rayburn, SRPA, PhD, is assistant professor in the department of economics and finance at the University of Mississippi, Oxford, Mississippi. He received a PhD in finance from Memphis State University, and was vice chair of the Appraisal Institute's Residential Education, Body of Knowledge, and Education Coordination Committees in 1991-1992.

Dennis S. Tosh, PhD, holds the J. Ed Turner Chair of Real Estate at the University of Mississippi. He received a PhD in real estate from Georgia State University and served as a trustee to The Appraisal Foundation from 1987 to 1992. Mr. Tosh has written numerous articles and books on real estate.

Roger King, PhD, is professor of finance at the University of Southern Mississippi in Hattiesburg, Mississippi, where he teaches corporate finance, banking, and investments. Mr. King received a PhD from Texas Tech University and has written many articles on financial institutions.

1. The eight U.S. appraisal organizations were: the American Institute of Real Estate Appraisers, the American Society of Appraisers, the American Society of Farm Managers and Rural Appraisers, the International Association of Assessing Officers, the International Right-of-Way Association, the National Association of Independent Fee Appraisers, the National Society of Real Estate Appraisers, and the Society of Real Estate Appraisers.

2. The Appraisal Foundation, "Purposes and Restrictions, Bylaws of the Appraisal Foundation," (Washington, D.C.: The Appraisal Foundation, 1987), 1.

3. Barnard Bill (H.R. 3675, November 20, 1987), 2.

4. Federal Deposit Insurance Corporation, Guidelines for Real Estate Appraisal Policies and Review Procedures (Washington, D.C.: Federal Deposit Insurance Corporation, BL-40--87), 1.

5. Ibid.

6. Office of Management and Budget, Circular A-129 (Washington, D.C.: Office of Management and Budget, November 25, 1988), 2.

7. "Functions of the Federal Financial Institutions Regulatory Agencies Relating to Appraisal Standards," Title XI, Financial Institutions Reform, Recovery and Enforcement Act of 1989, Public Law 101-73, USC 3339, 12. The federal financial institutions regulatory agencies are the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Federal Reserve System (FRS), the Office of Thrift Supervision (OTS), and the National Credit Union Administration (NCUA). Each agency has developed a set of final appraisal rules pursuant to FIRREA. The first compliance point in each agencies' appraisal rules is compliance with the USPAP.

8. USC 3350, 12.

9. Ibid.

10. For purposes of the appraisal regulations, the OCC and the FDIC have eliminated growing crops, growing timber, and mineral interests from the definition of real estate where a lien is not taken against the real estate.

11. Title 4, Section 472 and Title 2, Section 223 (d), Federal Deposit Insurance Corporation Improvement Act of 1991, 2386.

12. This date had been extended to December 31, 1991, by the Appraisal Subcommittee of the Federal Financial Institutions Examination Council.

13. Statement on Appraisal Standards, No. 5, the Appraisal Standards Board of The Appraisal Foundation, adopted September 10, 1991.

14. Federal Deposit Insurance Corporation Final Rules, 12 CFR Part 323; Federal Reserve System, 12 CFR Parts 208 and 225; Office of the Comptroller of the Currency, 12 CFR Part 34; Office of Thrift Supervision, 12 CFR Parts 506, 545, 563, 564, and 571; and National Credit Union Administration, 12 CFR Parts 701, 722, and 741.

15. The first of the 14 final rules as established by the financial regulatory agencies requires adherence to the USPAP. As a follow-up to USPAP adherence, each agency has written additional rules for the protection of financial institutions and the public.

16. As noted in The Appraisal of Real Estate, 10th ed. (Chicago: Appraisal Institute, 1992), 21, "Market value definitions can be found in a variety of sources, including appraisal texts, real estate dictionaries, and court decisions. However, for federally related transactions, the definition of market value as stated in the final appraisal rules of the federal financial institutions regulatory agencies must be used.

17. USPAP Standards Rule 2-2 requires an appraiser to identify the real estate being appraised, which could be accomplished by including a copy of the deed. However, USPAP does not require inclusion of the deed because this standard rule is directed toward a physical description of the property. The final rules of the regulatory agencies do require a legal description over and above the physical description required by the USPAP.

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Author:Rayburn, William B.; Tosh, Dennis S.; King, Roger
Publication:Appraisal Journal
Date:Jan 1, 1993
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