Appraising Diamonds on a Brass Rings

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In the context of a real estate appraisal, what is an overimprovement (or superadequacy)? Per the 14th edition of The Appraisal of Real Estate (p. 624) it is a “…type of functional obsolescence caused by something in the subject property that exceeds market requirements but does not contribute to value an amount equal to its cost…” (ibid; emphasis added).

A swimming pool is a prime example of an overimprovement. What a swimming pool contributes to value is likely far less than its cost new (even after deduction of age-life depreciation). Despite this relationship, it is rare to see a residential appraisal report in which there is a deduction for functional obsolescence because of the presence of a swimming pool.

Consider the issue of size. A 5,000 square foot house in a neighborhood of 2,500 square foot houses is likely a superadequacy. This superadequacy stems from the fact that the extra 2,500 square feet likely do not contribute to value at the same rate as the “necessary” 2,500 square feet.

The appraiser needs to explain any superadequate features of a property in sufficient breadth and depth so the client cannot accuse him/her of conducting a misleading appraisal, and then writing a misleading appraisal report.

Right or Wrong Appraisals

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An appraiser commented that a state should not sanction an appraiser for USPAP violations when the appraisal was “right”.  While this appraiser’s heart was in the right place, the comment evidences a logical fallacy all appraisers must avoid.

USPAP makes it clear that an appraiser forms a value conclusion based on Standard One, and then communicates it based on Standard Two.  USPAP does not contain any mention of an appraisal or appraisal report being “right” or “wrong”.  Indeed, it cannot since an appraisal (i.e., the value conclusion) is, by definition, an opinion.  An opinion is not a fact one finds. An appraiser’s opinion is either properly formed or it is improperly formed.  An appraiser then communicates it properly or improperly.

To assume an appraisal is “right” assumes the appraiser derives a property’s value via correct computations within a mathematical formula.  Alternatively, it assumes there is some benchmark value the appraiser must match, thus justify.  This is not true, not matter how much AMCs, brokers, buyers, and/or sellers complain to the contrary.

When an appraiser understands and then follows the precepts of Standard One, that appraiser has properly formed a value conclusion (no matter what the AMC’s phone monkey reviewer may conclude). When the appraiser communicates that value conclusion per the applicable Standards Rules of Standard Two, then the appraiser has properly communicated that value conclusion.

An appraisal is therefore never “right” or “wrong”.  An appraiser forms his/her value opinion properly or improperly.  An appraiser communicates his/her value opinion properly or improperly.  If these comply with Standards One and Two, the appraiser has little to worry about.  If they do not comply, then the appraiser has something to worry about.

The Client Accommodation Trap

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Appraisers try to accommodate their client’s interests. There is nothing wrong with this per se.  Appraisers commonly write, “at the client’s instruction…” or “per the client’s request…”, then the appraiser describes what the client instructed or what the client requested, as well as what the appraiser did to comply with the instruction or request.

This language, however, implies the appraiser is trying to do the appraisal, or write the appraisal report, in a manner that pleases the client, a potential USPAP violation. By definition, a real estate appraiser must be independent, impartial, and objective. Such accommodating language not only calls into question whether the appraiser has complied with these three qualifications but also smacks of advocacy.

Omit the offending language.  For example, appraisers commonly omit the analyses of the Cost approach. However, certain clients may request the inclusion of these analyses as part of the appraiser’s value conclusion. Instead of saying, “at the client’s request, the appraiser has included the protocols of the cost approach…”, please consider saying, “the appraiser included the protocols of the cost approach as both applicable and necessary to the formation of a credible value conclusion”, never mentioning the client’s request.

Complexities

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Complexities in appraisal work come up periodically, depending on the market you work in and the types of properties that are common to the area. I office in Colorado and have had the opportunity to appraise in rural and extremely remote areas. In the case of one particular market area, the trip one-way takes over two hours and is over 1,500 square miles; in this particular market, you’re lucky to have 30 sales over any two-year period – and that’s counting all residential properties, whether on a lot in town or a large-acreage parcel, a 90-year-old small house or a custom log house. You can bet there are complex assignments in this area. However, it doesn’t take a remote area to result in complex appraisal assignments.

Typically, complexities originate from two sources:

  1. Physical or locational characteristics of the subject property itself, and/or
  2. Limited sales or uniqueness in the area.

Complexities are a double-edged sword. If you only have two dozen sales in the entire area over a multi-year search period for selecting comps, and your subject is not located in a subdivision, you have to decide whether the glass is half-full or half-empty. Likely, there is no “model match” to your subject; however, you don’t have too many sales to sift through to choose which will give the best perspective in evaluating the subject’s value.

An appraiser doesn’t need to cover rural markets to experience similar dilemmas. All it might take is that 3,000 square foot GLA over-improved house in a subdivision of 1,500 square foot GLA houses, or the house with an indoor pool in the area with only starter houses, to appreciate that complex assignments area a test of our appraisal abilities.

But complexities are not an automatic reason to decline an assignment. Let’s be sure we’re prepared!

USPAP Compliance and Desktop Appraisals

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Many appraisers are worried that a so-called desktop appraisal will not be USPAP compliant if a third party to inspects and/or photographs the subject property.

USPAP does not make an issue of who inspects the property, nor who photographs it. USPAP does not require the appraiser to inspect the subject property. Nor does USPAP require the appraiser to photograph the subject property or the comparables. USPAP requires the appraiser to disclose the extent of the inspection of the subject property, which includes no inspection at all. Further, USPAP makes no mention of the need to include photographs of the subject as part of the formation of a credible value opinion. Both these requirements are a function of lender requirements, not USPAP.

Fannie Mae requires the appraiser to inspect the subject property, as well as to inspect the comparable property from at least the road in front of the it (assuming that’s possible). However, Fannie Mae has no requirements the appraiser take these photographs. In other words, a contractor the appraiser hires to take photographs could do this and the report would still be fully Fannie Mae, as well as USPAP, compliant.

An individual lender may require the appraiser to take the subject and comparable photographs him- or herself. If the appraiser agrees to this condition, then the appraiser has no choice but to do so. However, the key point here is that the appraiser personally taking the photographs of the subject and/or the comparables is a lender requirement, not a requirement of USPAP, and not necessarily a requirement of Fannie Mae.

Therefore, under certain conditions, an appraiser doing a desktop appraisal is perfectly USPAP compliant.  Providing photos is not significant appraisal assistance. The appraiser is under no ethical obligation to disclose the photographer’s name, nor the extent of his/her assistance.

Lies, Damn Lies and Inadequate Sample Size

Benjamin Disraeli was the Victorian era Prime Minister of the United Kingdom.  He famously said “there are three kinds of lies: lies, damned lies and statistics”.  He died in 1881.  This was after Sir Francis Galton coined the term standard deviation, but before he popularized concepts like of correlation and the Central Limit Theorem with his publication of Nature in 1889.

Perhaps Disraeli was witness to how misleading statistics could be without an understanding of sample size requirements.  Most people wander about in the same fog that engulfed Disraeli.

The Central Limit Theorem states that a sample size equal to or greater than 30 is required to make credible assertions about a population.  “In practice, the Central Limit Theorem allows us to make inferences about population means relying on the normal distribution when a) the population is normal or b) when n ≥ 30. As a practical matter, the sampling distribution of the mean will be approximately normal when n ≥ 15 and the population is symmetrically distributed. However, appraisers usually know very little about the shape of population distributions of price, property attributes, financing arrangements, and the like. Therefore, the n ≥ 30 criterion generally applies to real property valuation work.”[1]

In general, if the mean and the median of a population differ, the distribution is not normal and you need a sample size of 30 or greater.

[1] Marvin L. Wolverton, PhD, MAI, An Introduction to Statistics for Appraisers (Chicago, The Appraisal Institute)