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A review appraiser's perspective.

With the advent of an increased number of financial institution failures, a higher degree of regulatory scrutiny, and the passage of Title XI of the Federal Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), real estate appraisals are subject to increased quality control through the review process. Financial institutions have added personnel to meet the regulatory requirements, hiring staff reviewers as well as contracting review assignments to external appraisers. The appraisal review function is relatively new to the appraisal profession, and for fee appraisers in many parts of the country, an in-depth review is often a troublesome experience. The purpose of this article is thus to discuss appraisal review philosophy as well as some of the pitfalls of careless reviewing and to promote a better understanding between reviewers and appraisers.

THE PURPOSE OF A

REVIEW

As a result of the failure of many financial institutions in the Southwest and the Northeast, real estate lending is subject to increasingly strict underwriting guidelines. FIRREA clearly requires that the underwriting process include an appraisal. Therefore, the regulatory agencies have mandated that real estate lending institutions must have viable appraisal functions and adequate related policies and procedures in place. These policies generally include a procedure for reviewing appraisals, with the goals of ensuring that the report meets the regulatory guidelines, minimizing the effect of unacceptable appraisals, eliminating fraudulently prepared appraisals, and instituting quality control measures. Such reviews should result in more reliable real estate appraisals.

An appraisal is a series of judgments based on market information. The judgment aspect is thus critical, and the only way for a reviewer to determine whether appropriate judgment has been applied is to follow all the steps taken by an appraiser as revealed in the report. An appraisal is the product through which an appraiser explains the data, analysis, and conclusions used to derive a value estimate. The role of a reviewer is to determine whether a report meets the guidelines according to which it was prepared as well as whether the value conclusion is reliable. Appraisals do not exist in a vacuum; they are used by financial institutions to make investment, financial, lending, and collection decisions. Before those decisions can be made, it must be established that the reported values, including the methods and assumptions employed, are reasonable.

The review process can be a positive experience, providing fee appraisers with a better understanding of how the appraisals are being used as a basis for financial decisions as well as what those decisions comprise. This understanding should, in turn, help fee appraisers incorporate more material on areas of importance to clients. It is a reviewer's responsibility to convey any concerns to an appraiser in a positive, constructive manner. If the review process is handled in this way, the quality and professionalism of the industry will certainly improve.

All reviewers must comply with Standard 3 of the Uniform Standards of Professional Appraisal Practice (USPAP), (1) which governs the review process. Of primary concern to a reviewer is whether a report meets the regulatory guidelines under which it was prepared. If a report was prepared for a federally chartered or insured financial institution, it must conform to FIRREA and USPAP. According to FIRREA, an appraisal must

. . . be sufficiently descriptive to enable the reader to ascertain the estimated market value and the rationale for the estimate...provide detail and depth of analysis that reflect the complexity of the real estate appraised...contain sufficient supporting documentation with all pertinent information reported so that the appraiser's logic, reasoning, judgment, and analysis in arriving at a conclusion indicate to the reader the reasonableness of the market value reported. (2)

Standard Rule (2-2(h) states that an appraisal must "set forth the information considered, the appraisal procedures followed, and the reasoning that supports the analysis, opinions, and conclusions." (3) Reviewers' interpretations of these guidelines differ. While in one reviewer's opinion a report may meet requirements, another reviewer might believe the same report is insufficient. This determination is thus somewhat subjective.

Several different types of reviews may be conducted; it is therefore important to know the scope of the review. One type of review, an administrative screening or compliance checklist, simply ensures that all necessary parts are included within the appraisal. In this type of review, the judgment aspect of the appraisal often is not critiqued, and whether the value conclusion is reasonable and reliable is not verified.

The most widely used type of review, a desk review, is an indepth review; however, reviewers using this format typically do not physically inspect the property view the comparables, or verify data. A field review is more intensive and usually includes a subject inspection as well as data verification. Whether an appraisal meets the regulatory requirements must be determined; however, it is understood that this determination may be subjective in nature.

The reasonableness and reliability of an appraisal should be of primary concern to a reviewer. While all necessary parts of the appraisal might not be included or presented as adequately as desired, the value conclusion may well be reasonable and reliable.

A REVIEWER'S CONDUCT

DURING THE REVIEW

PROCESS

A new reviewer's first inclination is to be extremely critical of the report under review. First, a reviewer wishes to show an ability to recognize even minor faults. Second, there may be a desire to vent frustration resulting from previous criticism of the reviewer's reports during the apprenticeship period. While almost all fee appraisers have been recipients of such a negative approach, this type of behaviour is not conductive to the high level of professionalism required to meet the challenges facing the appraisal profession.

A reviewer must have had at least some appraisal experience to do the job correctly. Many attributes, including an ability to sift through a large amount of data and delineate the critical items relavant to value, are requiered. To really understand an appraisal report, a reviewer must have ability, expertise, experience, and appraisal knowledge. An understanding of the analysis techniques used is also necessary to enable a reviewer to determine whether a report is technically correct. Because there are many different ways to analyze real estate, it is critical that a reviewer understand a particular appraiser's methods. If a reviewer sees an unfamiliar type of analysis, it is that reviewer's responsibility to determine whether it is applied correctly. Otherwise, a reviewer has done a disservice to the client as well as to the appraisal profession.

Review appraisers must be open to new techniques. If an analysis is prepared differently than those a reviewer is accustomed to seeing, it is not necessarily incorrect. Exposure to many different report styles and techniques is a great learning opportunity for reviewers; they should regard it as such and be open minded.

If a report contains a few areas of concern, it is frequently heplful to discuss the problems with the appraiser. In such a case, a reviewer must be sure to communicate constructively. The following suggestions may be helpful in this regard.

* A reviewer should not convey that he or she has formed conclusions as to the appropriateness of an appraiser's conclusions. Rather, questions asked in a nonjudgmental manner are more productive (e.g., "Why, when all of the rent comparables were at $6 per square foot, did you conclude with a market rental rate of $12 per square foot? Is there something about the subject property that I missed?" This should produce more satisfactory results than "Your rental rate is too high and totally unsupported. How could you ever push it that high?").

* An appraiser must convince a reader that the data, analysis, and jusgment reasonably support the report's conclusion. A reviewer may thus present questions in this light, emphasizing that he or she hasn't been convinced that the conclusions reached in the report are reasonable and that more information or analysis would be helpful. This allows the appraiser to explain that he or she did, in fact, consider additional information, but that it was not cited in the report.

* Appraisers should be open to the questions of reviewers and avoid the urge to become defensive. Logical explanations increase the effectiveness of communication. The review process should be a positive one through which appraisers learn what clients are looking for in terms of report content, quality, and methodology. Both reviewers and appraisers can use the review process to understand new techniques and to broaden their perspectives. Although not always the case, the review experience can be an educational process that will improve our industry's professionalism and effectiveness.

PRESENTATION OF A

REVIEW

Once a review has been completed, it must be presented to the client. The presentation of a review should communicate constructively rather than simply criticize the report. Further, appraisers are often given copies of reviews. As in all business endeavors, much of the success of a review depends on its presentation. Several simple ways to improve the review reporting process and further promote professionalism follow.

* It is best to refer to "the report" as opposed to "the appraiser" (e.g., "The report did not address the toxic waste dump," rather than "The appraiser did not address the toxic waste dump."). This demonstrates that while the reviewer does not know that the appraiser did not address the fact, it is apparent that the report has not done so. In addition to being more accurate, this may also help to avoid defensiveness on the part of the appraiser. After all, the appraisal report and not the appraiser is under review, and written questions and comments should be structured in light of this perspective.

* A reviewer typically has not inspected the property, or spent two to four weeks on the research and analysis necessary to complete the appraisal under review. Thus, when discussing what the report does or does not consider or contain, a light touch is preferable (e.g., "It appears that the report did not consider the toxic waste dump.").

* A review should discuss the strengths and deficiencies of the appraisal. In addition, a review should determine what effect any deficiencies noted have had on the appraised value. For example, if entrepreneurial profit was not included in the cost approach, this may not have had a material effect on the appraised value, especially if the appraisal put only minimal emphasis on the cost approach. In such a case, the review should state that this problem does not have a material effect on the value estimate in the report. This is helpful to readers of the review who are not appraisal oriented.

* Often a few major areas are in question and require additional input, reanalysis, or correction. In addition, there may be numerous less important issues such as typos, language inconsistencies, rounding errors, and inconsequential mathematical errors. It is important to address the material issues that require attention while minimizing those issues that are not particularly material. If an appraiser receives a written letter listing every typo and nonmaterial error as well as the major ones, he or she may become frustrated and not bother to correct any of the errors. A review must be presented with some finesse, keeping in mind that the goal is to obtain a reasonable, reliable value estimate that conforms to the guidelines under which it was prepared as well as to inform the appraiser as to what type of information would help clafigy appraisals in the future. The eventual result is a better quality work product.

* A review must be worded professionally and not in a negative, condescending, or sarcastic manner. It may be the worst report ever seen; however, if so there will be many ways to demonstrate that fact in a professional manner. It should be remembered that one reason for the review process is to provide quality feedback to appraisers.

In a written review, a reviewer must make certain that the particular form requested by the financial institution meets the requirements of USPAP Standard 3. Although institutions may have varying requirements, it is generally a good idea to produce a "self-contained" review. A brief reiteration of the data including a subject description, highest and best use analysis, and the valuation techniques used is desirable. The review should contain significant discussion and analysis when reporting areas of concern. A comment on the adequacy and reasonableness of the appraiser's conclusions is often omitted by reviewers. A simple reiteration of the conclusions, however, tells an examiner or auditor nothing about the reviewer's opinion on the relevance, reasonableness, or reliability of the conclusions.

As previously mentioned, an appraisal may have a few material deficiencies, in addition to several nonmaterial matters. A perfect appraisal report is not necessary, however, for the financial institution involved to make a good business decision concerning real estate. If there are nonmaterial deficiencies, a reviewer should note them in the review, but should also state the range of materiality in his or her opinion. Material deficiencies will need to be addressed by either the original appraiser or the reviewer; however, for less important items, a mere comment frequently will suffice.

REASONABLENESS

Both FIRREA and USPAP guidelines are somewhat vague, allowing a reviewer a range of interpretation. While USPAP requirements are an attempt to specify the elements necessary for a good appraisal, a "real world" perspective should be maintained. The guidelines therefore must be interpreted with reasonableness in mind. Further, because value generally occurs in a range, a reviewer should comment on how the concluded value relates to the reviewer's idea of the reasonable range.

The techniques an appraiser used may be different from those the reviewer would have used. It may be helpful to reanalyze a section of the report in question based on the reviewer's favorite technique as a double check. If the conclusion is determined to be within a reasonable range it may be appropriate to accept it. In such circumstances, however, a review must contain significant analysis to support its conclusions, in accordance with Standard 3.

The procuring institution has a substantial investment of both time and money in the document under review. Because an appraiser is also more familiar with the property than is the reviewer, it is wise to give the appraiser the benefit of the doubt when appropriate. A reviewer's role should be one of trying to accept the report rather than trying to reject it. It is unacceptabale for an inexperienced reviewer to severely criticize and reject a reasonably supported appraisal that contains a reasonable value conclusion. With limited formal review training available, experience is extremely important.

CONCLUSION

Appraisal review, a relatively new facet of the appraisal profession, is here to stay. The federal regulators want the financial institutions to examine and analyze their appraisals more closely. Following is a summary of the most important factors in the review process.

* A reviewer must determine whether the report being reviewed meets the requirements of the regulations under which it was prepared.

* A reviewer should determine whether the value is reasonable and whether the value is reliable enough to be used as a basis for business decisions.

* Because value generally occurs in a range, a reviewer must determine whether the report being reviewed falls within a reasonable range.

* A reviewer should indicate the impact on the value estimate of any perceived problems in the report, without being overly critical.

* When drawing conclusions about an appraiser's report, a reviewer should remember that the appraiser is much more familiar with the property than he or she is. The appraiser should be given the benefit of the doubt when appropriate.

* When interacting with the appraiser and writing the review, a reviewer must be professional, communicating effectively and constructively.

The appraisal industry is at a crossroads. To adapt to the challenge of reviewing and being reviewed by their colleagues, both reviewers and appraisers must work together in an appropriate, professional manner throughout the review process. If this is accomplished, the result will be a higher level of professionalism and a more effective integration of appraisers and reviewers to help financial institutions meet their goals.

(1) The Appraisal Foundation, Uniform Standards of Professional Appraisal Practice (Washington, D.C.: The Appraisal Foundation, 1990), B-18.

(2) Department of the Treasury, Office of the Comptroller of the Currency, 12 CFR Part 34 Final Rule as published in Federal Register, v. 55, no. 165 (August 24, 1990).

(3) USPAP, B-18. Standards Rule 2-2 (h).

Christine A. Fisher, MAI, is the corporate chief appraiser for Fleet Norstar Financial Group in Providence, Rhode Island. She received a BA in management from Our Lady of the Lake University in San Antonio, Texas.

John H. Wright, Jr., MAI, is a principal in the full-service real estate appraisal and consulting firm of Aaron & Wright, Inc., in Houston, Texas. Mr. Wright received a bachelor of business administration degree from Southwest Texas State University. Throughout his career, Mr. Wright has appraised all types of commercial real estate as well as functioning as an appraisal reviewer and consultant.
COPYRIGHT 1992 The Appraisal Institute
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Fisher, Christine A.; Wright, John H., Jr.
Publication:Appraisal Journal
Date:Apr 1, 1992
Words:2818
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