Friday, March 30, 2012

Some Thoughts about Appraiser/Valuer Responsibility

Unfinished construction of beach condos in Brazil

This month has witnessed a certain game-changing event for the U.S. commercial appraiser profession – the first FDIC lawsuit against commercial appraisers since the Savings and Loan crisis over 20 years ago. (For the 54% of readers who are outside the U.S., the FDIC is the Federal Deposit Insurance Corporation, a U.S. government entity that seizes insolvent banks and tries to resolve bad loans.) This lawsuit is a precursor of more to come, based on the numerous legal actions already taken against residential appraisers.

Two Michigan appraisers are being sued because they performed an “as is” valuation of a residential subdivision as if it was complete, when in actuality development had not yet started. This led to a loan loss that contributed to the failure of Michigan Heritage Bank.

One of the appraisers had previously appraised the proposed subdivision exactly as it was, a proposed subdivision, but the developer contacted the appraiser at a later date to tell her that the project was complete and that the subdivision needed to be appraised as complete. The appraiser did so without going to the property to verify completion.

Perhaps the appraiser was duped, or perhaps she was knowingly complicit in this misrepresentation by her client and thought that exculpatory clauses in her report protected her. A typical exculpatory clause might read like this:

No responsibility is assumed for accuracy of information furnished by the client.”

Such a clause is standard in just about any U.S. appraisal report, but is this not just an abdication of responsibility? This clause evidently did not work, because she now finds herself and her boss being sued by the U.S. government.

This misrepresentation of an unbuilt property as complete without proper disclosure is a violation of U.S. laws and USPAP (Uniform Standards of Professional Appraisal Practice), yet I have seen this practice commonly done in other countries such as Singapore and Canada and have commented on this in previous posts.

I was recently involved in a similar situation in which two other appraisal firms valued an 85-year old, multi-story warehouse building with the assumption that the elevators worked. "How were we supposed to know that the elevators didn't work?" (I like to push the buttons, but if I get the common excuse, "the elevator just broke yesterday", I ask for evidence of a current elevator inspection certificate.) My client, a direct lender, never instructed the appraisers to make this "extraordinary assumption" which turned the search for the true market value into a meaningless academic exercise--a hypothetical estimation of value "as if the elevators worked".

The standard of appraisal practice today seems to be to value each property as if nothing was wrong with it, and then declare this assumption to be a limiting condition of the valuation report. It reduces an appraiser's sense of "duty of care".  Why bother to determine if the property is a SuperFund site (U.S. list of properties requiring toxic cleanup or remediation) when you can just assume that it's clean.  Why bother to verify that utilities are available to the site when you can just assume so?

One central problem of the appraisal/valuer profession is the abdication of responsibility

Now that I have had the chance to read appraisal/valuation reports from every continent except Antarctica, I find abdication of personal responsibility to be endemic to the worldwide commercial appraiser/valuer profession, which causes me to propose the following manifesto:

1. An appraiser or valuer should care about all users of his report. Not only must he care about the welfare of his immediate client, but also about others who could rely on his report. An appraisal report done for a mortgage broker, for instance, may also be the basis for a lending decision from a direct lender who could lose money if the property is overvalued. If appraisers want to earn the same respect as doctors, we should be mindful of that part of the Hippocratic oath which proclaims “Do no harm”.

2. Accuracy, rather than report length, should be the primary goal of the appraisal process, as that is what contributes most to the soundness of decisions based on appraisals. In the North American commercial appraisal profession, too much emphasis is made on constructing lengthy reports full of canned comments and not enough emphasis is made on research and analysis. Some appraisers even purchase software that adds pages more of canned comments. Reports can do without paper-wasting, tree-killing comments like “Los Angeles is on the west coast of the United States of America in the western hemisphere of Earth, the third planet from the Sun.” I have also found myself perplexed in the past by appraisal instructor who have said "Your estimate of value doesn't matter. Only the report matters." Ask any client -- of course, the value matters!

3. Appraisers need to verify important facts about the property being appraised. Tenants should be verified as occupying the space they are said to be occupying. Representations about building area or land area should be verified by measurement or by public documents. Entitlements or planning approvals should be verified by recent official documents or better yet, by calling on the relevant public agencies. Relying on a property owner's statements without verification just invites fraud.

4. Whenever doubts arise, the appraiser should investigate or recommend investigation rather than make the extraordinary assumption that nothing is wrong. If the financial statements do not seem credible, he should request tax returns. If the ceilings are stained, he should look at the roof. If a subdivision is dependent upon well water, he should request a well water report. Assuming that nothing is wrong turns appraisals into meaningless academic exercises that lead to overvaluation.

When I was starting out in this profession in the 1980s, I had a mentor who would tell me to "stop agonizing" and just put down a number. I'm glad I didn't follow that advice. He eventually lost his license and company.  My clientele pays me to agonize.

The application of professional appraisal standards

Professional valuation standards go part of the way in alleviating these aforementioned problems.

USPAP, despite being vague and watered down over the years, has improved the credibility of American appraisal reports and is also followed by many Canadian appraisers.

Internationally, IVSC (International Valuation Standards Council) has published a lengthy set of international valuation standards that would also improve valuation practice for commercial real estate and other asset classes, if followed, including a specific application standard for valuation of property interests for secured lending -- important for protecting the lending industry. It will be difficult to promulgate such standards, though, if IVSC continues to charge money for a book-length publication rather than publish it for free on the Internet. Unless there is a legal mandate or clients start insisting on valuations that meet these standards, I would not expect appraisers and valuers to go out of their way to buy this book. An appraiser declaring that his report has met these standards often faces the reality that the client does not know these standards or have access to them.

In the mean time, it would be a good thing if the commercial appraisers and valuers of the world could agree on a much briefer oath or manifesto that would protect the interests of those who rely on our reports, much like the Hippocratic Oath for physicians. You may say that I’m a dreamer, but I’m not the only one.
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