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But Fannie Mae says I don’t have to do the Cost Approach!!
By Tim Andersen, MAI
Published 9-1-20 Question: A reviewer is threatening to send one of my reports to the state appraisal board! She says that because I omitted the Cost approach from my analyses and the report, the report does not comply with USPAP. Do I have to do the Cost Approach in my appraisals?
I responded I have the right to leave out any approach I want to, so long as the appraisal is credible. She says that her supervisor said that leaving out the cost approach, as an error of omission, compromises the integrity of the appraisal, and thus is a violation of USPAP.
What is going on here?! For $350, I will not do a Cost approach with all of its details: the fee is too small. Help! What should I do?
Answer: Whew! There are many issues here to consider and some of them are conflicting. So, let’s address them one-by-one.
First is the omission of the Cost Approach. A lot of AMCs, lenders, and so forth do not like USPAP’s Scope of Work Rule since it puts on the appraiser’s shoulders what to do to develop credible assignment results. While the lender, etc. clearly want to control the appraisal process to their benefit (see the entirety of the Fannie Mae Selling Guide to see this is true), from an appraiser’s standpoint, the Scope of Work Rule frustrates them in this desire (thus, the conflict this blog mentions
Scope of Work Rule
In the Scope of Work Rule is the clear language that the appraiser (not the client!) “…must…determine and perform a scope of work necessary to develop credible assignment results…” Because of the inclusion of the word necessary, it is equally clear the scope of work, for good or ill, is entirely in the hands of the appraiser. It is likely the client will suggest the appraiser do/not do something as part of the appraisal development process. But, in the end, the appraiser signs the Certification, not the client, so the appraiser chooses what does and/or does not go into an appraisal.
Then, from the same Rule, we understand the appraiser has “…broad flexibility and significant responsibility in determining the appropriate scope of work for an appraisal…assignment” (ibid). That you chose to omit the protocols of the Cost approach from your appraisal and report was entirely your call. However, the language of these lines also makes it clear that you are also entirely responsible for any ramifications (positive or negative) of that election.
So, now we consider the question of whether omitting the Cost approach has compromised the credibility of your appraisal and/or if that omission misled the client in any way.
To do so, go first to USPAP’s definition of credible, which is “worthy of belief”. Then read the Comment to the definition. “Credible assignment results require support by relevant evidence and logic, to the degree necessary for the intended use”.
Then page over to the Record Keeping Rule (ibid.) in which USPAP makes it clear the workfile must contain “…all other data, information, and documentation necessary to support the appraiser’s opinions…” (ibid; emphasis added). This raises the question, “how can a workfile contain the data, information, and documentation (and, thus, the analyses) of an omitted approach”. The only answer is, “It can’t”. And therein lies the problem with the reviewer.
That the reviewer is asking this question means the reviewer concludes the Cost approach should have been part of your appraisal. For the moment, assume the reviewer’s comment is wrong. That error on the reviewer’s part raises its own question to you, the appraiser: “When I omitted the protocols of the Cost approach from my appraisal, did I properly explain why I took that step; and did I properly explain how/why that omission would not affect the credibility of my appraisal report, nor mislead the client in any way?”
This lack of proper explanations may be the crux of the reviewer’s argument: by omitting the protocols of the Cost approach, and the evidence to be gleaned from it, as well as the mathematical logic of its use, did you negatively impact the credibility of your value conclusion? If that omission did not affect the credibility of the appraisal, nor mislead the client in any way, then all that is missing from the report is a proper explanation of why you chose to omit it (a problem easily fixable).
On the other hand, if that omission resulted in a non-credible appraisal, or if it served to mislead the client in any way, then there is likely a USPAP violation. This could be of SR 1-1(a) [competency]; SR1-1(b) [an error of omission]; 1-4(b)(i-iii) [cost approach]; SR2-1(a) and (b) [misleading the client; writing a report the client could not understand]; and/or SR2-3 [the Certification]. Perhaps these are the problems the reviewer has with your report.
Look carefully at SR2-3, the 8th bullet point. You certify to this every time you send out a report. It reads that, to the best of your knowledge and belief, your “…analyses, opinions, and conclusions were developed, and this report has been prepared in conformity with [USPAP]”.
Omitting the Cost approach, if it was necessary for the development of a credible value opinion, means that you did not develop your value conclusion in conformity with USPAP, despite the fact you swore to it. Certifying to such an omission is misleading prima fasciae. Do I have to do the Cost Approach in my appraisals?
Yet, if you can clearly and persuasively support your conclusion to omit the Cost approach, the reviewer can still whine and moan about it, but those actions would be ineffective. Nevertheless, there are some pitfalls with this line of reasoning, you’ll have to overcome:
SR1-4(b) [which refers to the cost approach] requires the appraiser to “…develop an opinion of site value by an appropriate appraisal method or technique…” when the “…cost approach is necessary for credible assignment results…” (ibid; ll. 521 to 524).
What this means is if you analyze a property via the protocols of the cost approach, you must also develop an opinion of site value via an appropriate method or technique (not by backing into it). After all, how can you make adjustments to a comparable’s site value without already knowing the current market values of both the subject and the comps as if vacant? Nevertheless, inclusion or exclusion of the protocols of the Cost approach are the appraiser’s call, not that of the reviewer.
According to SR1-4(b)(iii) [ibid; ll. 521 to 528], as part of the Cost approach, the appraiser analyzes “…such comparable data as are available to estimate the difference between the cost new and the present worth of the improvements…” in order to calculate (accrued) depreciation. Per this SR, using solely the data of pre-printed depreciation tables is not an acceptable protocol. Indeed, it may be misleading unless the appraiser explains these tables are not able to allocate accrued depreciation to its components, thus tend to lump it into physical depreciation.
Omission of any standard appraisal protocol, without a proper (and potentially lengthy) explanation, is potentially misleading and implies a lack of competency [not knowing when to omit/include something] and/or bias on the appraiser’s part [omitting an approach could imply you’re following your client’s instructions].
How to explain the omission of Cost Approach
How did you justify and explain the omission of the Cost approach from your report? An “explanation” such as “At the client’s request, I omitted the Cost approach from this appraisal” is neither a justification, nor an explanation. Indeed, it could indicate bias toward the client, and/or advocacy for the client.
To state merely “Given the subject’s age and the difficulty calculating accrued depreciation in older properties…”, too, is neither an explanation nor a justification. It could also communicate a lack of competency on the part of the appraiser since knowing how to calculate depreciation [see SR1-1(a)] is a basic competency. Here is but one template to justify the omission of the Cost approach (if this one is not acceptable to you, please use another one): As the sales and listing data elsewhere in this report amply demonstrate, there have been numerous sales and listings of properties competitive with and comparable to (C&C) the subject over the last 12 months.
Further, given the majority of the C&C residences have a year of construction prior to 1980, the majority are over 30-years old. Given this, there is essentially no new construction in this neighborhood since all of the sites here were developed long ago. Therefore, the sales prices of these C&C properties already reflect whatever accrued depreciation there is in the market. Therefore, there is no reason to calculate or quantify these.
Highest and best use
A determination of the highest and best use of the site as if vacant is not necessary for this appraisal assignment since the market-determined that long ago: development with a single-family residence in balance with the other SFRs in the neighborhood.
To raze or not raze the improvements is not a value issue affecting the subject.
While the residences here are typically over 30-years old, they are still too “young” to consider razing or re-purposing them. Therefore, the cost approach, which plays a major role in deciding whether to raze or not to raze the existing improvements, etc., has little, if any, practical applicability in the current assignment.
So, after determining these current market characteristics via analysis of the economic and supply & demand trends in the subject’s market area, the appraiser concluded the protocols of the Cost approach were neither applicable nor necessary to the formation of a credible value opinion in this valuation assignment, thus omitted it from the appraisal.”
Now, on to your issue of fees: USPAP does not address that issue. Rather, it is up to the appraiser to negotiate a reasonable appraisal fee with the client. It is true the potential client will likely offer the appraiser a fee with which the client is thrilled (but insults the appraiser).
However, if the fee is insufficient to allow the appraiser both to comply with USPAP’s due diligence requirements, as well as receive proper compensation for time, effort, etc., then the appraiser must either negotiate a more reasonable fee, or the appraiser must decline the assignment. (Note: it is not the client’s responsibility to keep appraisers in business. That is the appraiser’s job).
It is our responsibility to make ourselves competent. When we are, we are thereby able to command fees commensurate with our training, education, and experience.
To sum, then, your reviewer’s statement may or may not hold water. It is likely the protocols of the Cost approach are applicable to the solution to the appraisal problem in any single-family residential appraisal (e.g., a house, but not a townhouse, row house, or condo). However, those protocols may not be necessary for the formation of a credible value opinion. Only the appraiser can answer that question, and then only on an assignment-by-assignment basis.
In line with this, the appraiser demonstrates competence when s/he knows what to do in any appraisal situation, then executes that knowledge in a manner to form a credible value opinion. Finally, the appraiser communicates it in a manner not to mislead the client.
It is this competency in so many areas of real estate appraisal that marks us as professionals (or not). It is our level of professionalism that allows us to command fees commensurate with that professionalism.
If I can ever be of service to you in answering questions on USPAP, or any area at www.appraisersadvocate.com
About the author
It will be an honor to work with you. Thanks!
Be safe and well! If I can ever be of service to you in answering questions on USPAP, or any area of real estate appraisal, please contact me at firstname.lastname@example.org .
Florida State-Certified General Real Estate Appraiser, RZ998
Master of Science Degree (MSc) in Real Estate Appraisal
MAI Member of the Appraisal Institute
AQB Certified USPAP Instructor, #44754
IDECC CDEI #67601
NAA Board-Certified in Appraisal Review
Practice limited to:
USPAP Instruction (QE and CE)
USPAP Consultations for Appraiser Defense
USPAP Expert Witness Testimony and Consultations
Standard 3 & 4 Reviews for USPAP Compliance
CE and QE Writing, Instruction, and Consultations
CE Course Development and Presentations
Appraisal development & reporting consultations
Page 16 September 2020 Appraisal Today