Practice of Appraisal Review FHA Protocol Course No. 145

Columbia Institute Practice of Appraisal Review FHA Protocol Course No. 145 Instructor: Email: Phone:

Welcome – A Bit of Housekeeping Please complete your registration Course No. 145 Class time 8:00 a.m.-5:00 p.m. Lunch at Noon for 1 hour Breaks will be given in morning and afternoon No taping, recording, texting or laptop use during class time Topic Relevant Questions are welcome, Filibustering is not.

Welcome – A Bit of Housekeeping Please avoid talking between yourselves or over other classroom discussion; one conversation at a time is for everyone’s benefit Transcripts are prepared for those who pre-registered a minimum of 10 days prior to class; all others will be mailed within 5 business days from date school receives materials from instructor Transcripts available are given after course evaluation is completed at the end of the class (last 10 minutes of day)

Course Objectives Upon completion of this course you will be able to: • Advise clients on specific assignment requires • Associate relate Economic Principles of Value ton the Review Process • Review Scope of Work and Limitations • Read Quick Tips of Revised Handbook 4150.2 Appendix D • Correlate Revised Appendix D to the URAR • Identify Specific Repair and Inspection Guidelines • Understand the FHA Roster Appraiser Independence • Review the requirements of the FHA appraiser’s completion of the 1004D

Introduction to Appraisal Review • USPAP defines the role of the review appraiser and the act of reviewing • Standard 3 guides how the valuation service categorized as review should be performed • USPAP defines review as: the act or process of developing and communicating an opinion about the quality of another appraiser’s work

First Step in An Appraisal Review Identify the Problem in order to understand the Scope of Work necessary to complete the assignment competently and report ethically the results If developing an opinion of value within the review assignment adhere to Standard 1; in some assignments the review may be of the report only and not considerate of the real estate or real property interest

First Step in An Appraisal Review In those assignments involving a review opinion that includes a judgment of value the assignment is two-fold it is an assignment which includes: 1. A judgment about the quality of the work and 2. An opinion about the value albeit concurring or differing

Using Unverified Data When reviewing the data in an appraisal report in order to form an independent opinion some data may not be verified such as interior information that can’t be observed from a field review, exterior only observation. The need to rely on uncertain data requires an extraordinary assumption. It’s not necessary to label the assumption “extraordinary” but it is necessary to state in the impacted areas of the report those uncertain data areas. Also, ensure that when that assumption is made you also warn the intended user of potential impact on conclusions/value.

Working with Extraordinary Assumptions The reviewing appraiser can accept the appraiser’s data about local market conditions but disagree with methodology or techniques applied The reviewer may not concur with some of the assumptions the original appraiser made which could lead to a different value conclusion In any case of disagreement between the field appraiser and the review appraiser the users can choose to accept whichever appears to be the most credible

Common Misunderstanding Review appraisers are not primarily concerned with value; Any value opinion must be related to a date The review appraiser can agree with the opinion as of the same date or as of a different date Sometimes review reports are used in lieu of appraisal updates Review Appraisers’ can rely on data unavailable to the original appraiser

Independent, Impartial and Objective • A review of another’s work requires objectivity achieved by using accepted techniques and methodology when possible, together with sound reasoning • There are five commonly accepted areas of a reviewing appraiser’s knowledge • Intended use/user of the work under review • Economic Principles of Value • Specific Performance Standards of the USPAP known as Standard Rules • Typical Practice Based on Actions of Peers and Users • Personal professional opinion

Putting it all together • Scope of Work • Intended user and use dictate the work under review • Economic Principles • Affect the value of goods and services • Apply to the value of the land and the improvements • Contribution • Compatibility • Highest and Best Use

Economic Principles Characteristics of Real Estate Affecting Application of Valuation Principles 1. Immovable 2. Durable 3. Long Life 4. Heterogeneous (being unique in characteristics as no two grains of sand are alike no two parcels of real estate are exactly alike)

Economic Principles Principles fall into two divisions (I ) Productivity or (II) Marketability and within three categories 1. Market Area Principles 2. Land and Improvement or 3. Investor

Economic Principles

Supply and Demand A fundamental aspect of value is scarcity. In the Principle of supply and demand the supply on a given date in a specific area refers to a commodity’s relative scarcity. • Supply of real estate is dependent upon the availability of capital necessary to develop it to its highest and best use. • In real estate the quantity supplied is typically slow to adjust to changes in price • The slowness is attributable to the length of time required to bring new improvements into existence

Supply and Demand • Supply of real estate is dependent upon the availability of capital necessary to develop it to its highest and best use. • In real estate the quantity supplied is typically slow to adjust to changes in price

Supply and Demand • The slowness is attributable to the length of time required to bring new improvements into existence; while quality can change rather rapidly when modernization or remodeling are involved changing the appeal • Demand for real estate is created by utility in terms of quality as well as quantity

Highest and Best Use • Highest and Best Use is a Land and Improvement Principle that represents productivity; it is a conclusion of a site’s maximum productivity • It’s always a required step of the appraisal process in a Market Value opinion and it is always a two-step series of tests when the land is improved (tested first as vacant and then as improved) • In “cookie cutter” subdivisions in urban and suburban markets a residential appraiser may not feel challenged in the analysis but that does not negate the obligation to perform the analysis and offer supportive reasoning in the appraisal report (see SR 2-2 (a), (b) or (c) ix)

Substitution • A Marketability principle under the “User” category states “…prudent purchasers would pay no more for real properties than the costs of acquiring equally desirable substitutes on the open market.” • Because the “User” will pay no more it represents a high end decision on the buyer’s behalf when deciding to purchase at that price

Principle of Balance • In all transactions each real property has three combining components to the improved land that when in proper proportion represent a balanced contribution for which value can then be optimized • Those three improved land components are known as part of the agents of production. Those improved components are Labor, Capital and Coordination (land would be the fourth agent always last to be satisfied/considered in the investment).

Surplus Productivity • Surplus productivity is a consequence of the income remainder after the income has been identified for its contributory respective production agent • The last agent to be satisfied is always the land. Example: Land purchased for $ 50,000 Labor expense to construct $100,000 Materials, permits, impact fees and marketing $112,000 Coordinating contractor expects $ 15,000 compensation for risk and credit and effort to put it together. Total $277,000 Sale price $280,000 ???????? Surplus $ 3,000 Land is now worth $ 53,000 as the surplus residual is a result in the increase demand for the land as improved

Increasing and Decreasing Returns • When successive increments of one or more factors of production are added to fixed amounts the other factors will result in an enhancement (increased value) up to point upon which the depreciation or lack of demand over time will ultimately result in a decrease in the return. • Example: The Dwelling is built 12’ feet above ground due to flood history. The weekly rental of the unit is $700. The cost to put in a cargo lift which allows transportation of luggage, groceries, etc. is $15,000 but the increase in weekly rent is projected at $1,100 per week. The life of the cargo life is 12 years, cost of lift is paid in <1 yr., with increasing repair costs over time the cargo lift will create a decreasing return.

Principle of Change • Property values are dynamic not static. Simply stated, the Market Principle of Change states that “nothing stays the same”. • Appraisers’ often make adjustments to the sales prices for “time”, which is in reality “changes in the market” since then sale. • The non-liquid asset of real estate makes the market less volatile than a commodity market, i.e. values tend to move more slowly.

Principle of Conformity • Deed Restrictions and good planning for the land affords a uniformity of improvements that generally maintains value. • A mixed use neighborhood/market area can rarely achieve a stable demand because the area lacks homogeneity/conformity. • Conformity not only refers to use; other characteristics which should conform include: • Price ranges, • Style, • Construction techniques, • Size, • Design, etc.

Anticipation • The value paid for real estate reflects the investor’s current opinion of value based on the investor’s anticipated benefits. It is the present worth of an anticipated use and expected resale of the asset. • Value of a property is based on neither the price paid for it in the past nor on the cost of its creation, rather on what participants in the market perceive to be the future benefits of acquisition.

Competition • This principle holds that profits tend to breed competition and excess profits tend to breed ruinous competition. • A healthy economy is one that is stable in its supply and demand. Competition aids in that stability when there is balance between the supply and demand of a property type. • It is this principle that in part drives the request for absorption analysis in the 1004MC. That analysis affords a window into the economic conditions that impact the marketability of the subject.

Essential Elements of Value

Review of Approaches • In the Appraisal Process the Approaches to a Market value come after the problem has been properly identified and preliminary analyses: • Market • Site • Improvement • Marketability and • Highest and Best Use have been performed. • Within the Scope of Work decision one or more of three approaches are performed in relationship to the quantity of data, the quality of the data and the appropriateness of the approach is determined. The driver in the decision to use any of the approaches to value is credibility within the context of the intended use.

An Overview of the Cost Approach • This approach represents an economic analysis of the decision of a buyer broken down through separating the land from the improvements. In an existing improved appraisal assignment the replacement simulated construction cost is developed and then adjusted downward for any loss to the cost new from one or a combination of three causes 1) Physical, 2) Functional, 3) External. • The site improvements contribution are part of the Cost Approach but not contributive under the same term of economic life as the dwelling and car storage. • If the buyers in a market considered either building new or purchasing an existing property when the decision to purchase was made and there is sufficient quantity and quality of data the Cost Approach is both applicable and necessary to the developed value opinion.

An Overview of the Cost Approach • Reproduction is defined as building an exact replica whereas Replacement is defined as constructing a structure of similar utility • The principle of substitution plays an underlying role in the Cost approach, i.e. no one would pay more to purchase land and build improvement than they would to purchase a similar property, however the true underlying principle of the Cost Approach is the principle of Contribution. • Under the principle of Contribution the improvement’s value is not based on their Cost, rather what the market says through analysis of comparison the contribution

AnOverview of the Cost Approach • The Cost Approach is both applicable and necessary in developing a value opinion when: • the buyers in a market considered comparison of either building new or purchasing an existing property and • when the decision to purchase was made and there is sufficient quantity and quality of data.

AnOverview of the Cost Approach • It is true that replacement cost may set an upper limit on value for improvements. • However, when depreciation is properly accounted for the value conclusion of these joined elements will be in line with the other approaches indicators of value.

An Overview of the Cost Approach • One of the more interesting observations are the intangibles in the Cost Approach. • For example • Value of a special view would belong to the site • A celebrity owned or occupied property is more often connected to the improvements as opposed to the site • In some cases the decision to buy existing as opposed to building new is a factor of time. The buyer is in many circumstances is more interested in moving in quickly as opposed to waiting for the new construction. And, the desire for immediate occupancy results in a price paid that is a higher amount for current possession. In that circumstance the land as improved is more appealing than the land as vacant.

AnOverview of the Sales Approach • One of the more common approaches is the Sales Approach. • Sometimes referred to as the Direct Sales Approach or the Market Approach • Process requires (below is quoted from revised Appendix D to Handbook 4150.2): • Only closed (settled) sales may be used as comparable sales 1, 2 or 3. If a sale is over six months is used, an explanation must be provided. • No sales over one year old are permitted except as “additional comparable sales” and would be identified as comparable sale(s) 4, 5 or 6. • Any combination of conventional, FHA, VA or cash sales are acceptable as comparable sales.

An Overview of the Sales Approach • One of the more common approaches is the Sales Approach. • Sometimes referred to as the Direct Sales Approach or the Market Approach • Process requires: • Locating Most Recent Sales of Similar Property Types in the nearest proximity to the subject as possible • Adjustments are initially made for: • Excessive Sales Concessions and • Market Conditions/Time when the market is in motion and the sale price will obviously reflect a historical price paid

An Overview of the Sales Approach • Once adjusted for the current real property price (unaffected by Interested Party Contributions IPC’s) and for changes in the market (known as Market Conditions or Time) then other items of dissimilarity can be adjusted to ensure comparative properties that are prices paid for: Item Adjusted Price Reflects Location Immovable Property Here Property Interest Ownership Type to ensure comparison is based on similar benefits NOTE: When reviewing dissimilar locations ensure there are supporting comments also found in the neighborhood

An Overview of the Sales Approach • Being adjusted for all key factors of major significance the lessor dissimilar items can be addressed. Item Adjusted Price Reflects Site Ensures comparative lots/land parcels View Stabilizes any market reaction for the visual impairments or enhances that are either inferior or superior to the subject NOTE: When reviewing these line adjustments ensure there is consistency in the neighborhood comments for lot sizes typical of most residential homesites and attractions or detractions connected with what is seen from the site. There should also be comments on the subject’s comparative characteristics in the site section of the report

An Overview of the Sales Approach • The next two items should be stated as the base expectation of the market in the neighborhood. Only the significant differences will require an adjustment Item Price Reflects Market Reaction/Acceptance Design Style Generally there are dominant styles of housing previously summarized in the neighborhood Quality of Construction In many circumstances the quality of construction corresponds to the design style. To qualify for an adjustment there should be strong evidence of those dissimilar building components and/or finishing corresponding with neighborhood comments Note: Be careful not to Confuse the two line items. One is related to the visual Conformity while Quality is Related to how and what type Improvements are assembled

An Overview of the Sales Approach • Condition and Age can often be “double dipped” in the sales approach Item Adjusted Price Reflects Condition Present State of Wear and Tear As compared with market Note: If the subject were 12 years actual age but showed comparatively to other 10-15 year old dwellings a maintained property it would probably be concluded as “average” condition but if the floor cover and central condenser unit had recently been replaced when surrounding sales had not yet had that type of replacement it would probably be concluded as “good”

AnOverview of the Sales Approach • ”Double Dipping” Condition and Age Item Adjusted Price Reflects Age As stated on the line it is asking for the actual age Note: For FHA the directive is very specific. Actual Age Enter only the actual age of the subject of each comparable sale. (Direct Quote from Appendix D) If appraiser chose to adjust for effective age that effective age should be entered on blank lines at end of itemized line items. There should be no condition adjustment in addition to effective age differences as the effective age reflects condition (exception is when using the Modified Age-Life Method where incurable is treated in the age and curable in the condition differences).

An Overview of the Sales Approach The reviewing appraiser should carefully consider FHA’s directive when reviewing the Sales Approach for the adjustments used by the appraiser. • Adjustments are made to the price of the sale properties for price-influencing dissimilarities between each sale and the subject property • Not all dissimilarities require adjustment because not all dissimilarities achieve price differentials in the market • Be careful that adjustments are reasonable and not excessive • Make adjustments only if the dissimilarity has a noticeable effect on the value

An Overview of the Sales Approach • Normally, it is considered that there must be at least three closed sales, although pending sales can also be used and are often requested if known as additional indicator • Listings would be the indication of the upper limits of value • Computerized data and also become an analytical tool such as a regression analysis; notice the next Power Point slide to view both the sales used in the approach and the regression analysis

Viewing indicators of Value in the Sales Approach • The four adjusted sales of the case study show value conclusions of: • $90,400 • $87,580 • $86,000 • $89,500 The regression scatter used 10 sales and shows the price to square foot of living area will be near $90,000. Sale price of Subject is $88,000 The Sales Approach in the Case study reconciled at $88,000

USPAP • SR 1-2 (on page IV-2) elaborates the assignment elements of the real property appraisal • Assignment elements are an integral part of the problem identification including assignment conditions and end with a demand to determine appropriate scope of work necessary to develop a credible appraisal

USPAP • SR 1-3 (on page IV-3) is the land use standards of practice which has its focus on developing market value with emphasis on analyzing not only the subject but also surrounding land use • SR 1-3 (a) comments demand support for market trends, remaining economic life and effective age • Look at the Case Study, can you go through the URAR form and identify SR 1-2 items (a) through (h) and identify the necessary analyses that the appraiser should have developed?

Standard 3 • First Step is to identify the problem • Second, determine the scope of work necessary to solve the problem and • Correctly complete research and analyses necessary to produce a credible appraisal review • SR 3-1 is the Competency Pre-Requisite to perform the review • SR 3-2 outlines the specific steps within the reviewing appraiser’s minimum required Scope of Work

Standard Rule 3-3 • SR 3-3 (a) requires the reviewer to develop an opinion as to the: • Completeness • Accuracy • Adequacy • Relevance, and • Reasonableness of the analysis of the work under review

Standard Rule 3-3 • SR 3-3 (c) is only applicable to the review assignment that involves the reviewing appraiser to also form an opinion of value • SR 3-3 (c)(i) requires Std 1 be followed when reviewing and also forming an opinion about real property value • SR 3-3 (c)(ii) requires Std 3 be followed when forming opinion about the quality of the work • SR 3-3 (c)(iii) speaks to appraisal consulting that requires a review of a real property appraisal with a value opinion

Standard Rule 3-3 • Comments to SR 3-3 (c) state the following: • These requirements apply to: • The reviewer’s own opinion of value when the subject of the review is the product of an appraisal assignment; • The reviewer’s own opinion regarding the work reviewed by another when the subject of the review is the product of an appraisal review assignment; or • The reviewer’s own appraisal consulting conclusion when the subject of the review is the product of an appraisal consulting assignment

Practice of Appraisal Review FHA Protocol Course No. 145