Monday, November 11, 2013

Critical Thinking Skills Needed for Real Estate Appraisers and Valuers

My posts on Scotland and Trinidad in September were critical of "chartered surveyors" who allowed false information to enter the valuation process with exculpatory phrases such as “the developer informs us that…” without verifying such information, even if it seemed preposterous. I did not intend to suggest that chartered surveyors were worse than valuers and appraisers elsewhere.  The same problem exists  throughout the world, including my home country of the USA.

Part of the problem is that “critical thinking” skills are not part of the valuer’s training in any nation where I have interacted with local valuers. 

In the English-speaking world, valuers are trained using “business school” methods.  Instructions in problem-solving start with set, unchallenged assumptions, and the question is not asked, “What if the information and assumptions are wrong?” or "What if the property owner is lying?" There is an intermediate step which is being neglected, the step that consists of verification, exemplified by such questions as "How do we know that the building measures 25,000 square feet?" Did we measure it? Did a government entity measure it?  Did we get the number off the rent roll? (Rentable areas are often inflated by landlords.) Or were we just "informed" by the owner?


Consider, for instance, that the larger the property, the less likely it is that the appraiser will measure it.  In a recent appraisal of a 44-structure industrial campus, the owner represented building area as 256,000 square feet, claiming the measurements to be from the county tax assessor's office. The assessor's measurements were 54% smaller.

In Latin America and some other nations, valuers enter the profession through the field of architecture or engineering, and their more scientific education is even more dependent upon problem-solving that starts with set, unchallenged assumptions. I find many of these architects and engineers overly rely on the Cost Approach and also lack skill in discerning current market conditions (which need to be known in adjusting the Cost Approach for “external obsolescence”, the loss in value due to unfavorable market conditions or external adverse influences).

Imagine if all appraisers and valuers verified the information about the subject property that they relied on.  The world would receive more accurate valuations.  Instead, trainers of valuers indoctrinate their students into providing multiple “Assumptions and Limiting Conditions” that merely serve as disclaimers that complete due diligence was not performed, and then they have the nerve to call this "good appraising"! Remember that "Assumptions and Limiting Conditions" serve to protect appraisers and valuers from liability and not to protect the client.  Take the following example:

In the Scotland post, (http://www.internationalappraiser.com/2013/09/appraisal-of-former-naval-base-in.html), I spoke of a former munitions site appraised as the site of a new, 5-star hotel, with the valuer stating the assumption that no environmental contamination was present (almost never the case with a munitions site), even with abundant metal scrap visibly leaching oxides into the soil, underneath signs warning persons to keep out due to ongoing asbestos removal. 
Making this assumption in the “Assumptions and Limiting Conditions” section of an appraisal is not good appraising; it is aiding and abetting fraud. Sure, a valuer is not professionally trained in measuring environmental contamination, but a valuer does not have to be an environmental expert to state visible evidence in his or her report.

Once I had a debate with another appraiser on an on-line appraisers' forum.  I mentioned that I had one client who insisted that I inspect the roof on every building that I appraised for them.  This other appraiser insisted that roof inspections were outside the scope of an appraiser’s duties and that it was even unethical to state my observations because it would infer that I was representing myself as a roofing expert. That had been what he was taught.

I remember a situation with a former Honeywell building in Minnesota in which missing or worn-out roof flashings resulted in rain and snow melt leaking down inside the exterior walls and destroying several hundred thousand dollars of computer equipment. Now which appraiser is more likely to get sued – the one who pointed out the obvious hazard, or the one who performed an incomplete property inspection and had the attitude of “That’s not my job”?

The truly concerned appraiser or valuer (who cares about his clients) needs to think about whatever may affect the market value of the property.  This includes being properly informed in matters of construction and design, environmental hazards, flood zones and protected wetlands, demographic analysis, and microeconomic analysis of the equilibrium between supply and demand.  Anything less could make the valuation a meaningless academic exercise and is an abdication of professional responsibility.  It can also hurt the client.

This also answers a question I occasionally get asked, which is why do I get sent overseas to perform valuations where local appraisers are available?  The answer is that I offer my clients extra due diligence that they have learned not to expect from other appraisers or valuers, who instead provide pages and pages of disclaimers and limiting conditions. When others say "That's not my job" I say "I will make it my job."


But let us take "critical thinking" to an even higher level.  Shouldn't we as appraisers and valuers also question valuation techniques that may be incomplete or unsound to begin with? 


The appraisal profession has been deficient in its use of discounted cash flow (DCF) analysis, for instance. Some appraisers and appraisal organizations think that future expenses will grow no faster than future income, when in reality, a building is a deteriorating asset and expenses will almost always increase faster than the rate of price inflation. So many commercial loans have failed because reliance was placed on an unrealistic DCF analysis.

Appraisers have also been surprisingly resistant to the concept of looking at listings as comparable sales data. If listings are found indicating lower market values than most recent sales, this is the warning indicator to inform appraisers of a declining market. In that case, listings will indicate the new, reduced ceiling of value.

Some appraisers refuse to use comparable sales that are foreclosures or in foreclosure, even if the appraised property is also in foreclosure. This can result in overvaluation.

Critical thinking can sometimes fly in the face of professional orthodoxy, which may not always hold up to logic. There is a status quo maintained by professional "Grand Poobahs" whose power is dependent upon a lack of change.  Professional orthodoxy is sometimes not that much different than a religion. Many years ago, religious leaders were asked the question, "What would you do if Science invalidates part of your religion?" We all know that the Earth is not flat. The answer that impressed me most was from the Dalai Lama. He said, "Then Buddhism would have to change." Likewise, the appraisal profession will also need to change. 




PS:  For younger or foreign readers, the above illustration is of a television character named "Sergeant Schultz", an incompetent prison guard played by John Banner in the 1960s television sitcom "Hogan's Heroes". His stock phrase was "I know nothing, NOTHING!" even though he sometimes knew that his prisoners were up to no good, but he could be persuaded to look away by a piece of chocolate.  

13 comments:

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Dusty said...

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I am a residential appraiser in rural Colorado. I recently read a book on critical thinking and found that everything in the book applied directly to my profession. The objective of this profession is to provide a reliable opinion. Your article confirms my conclusion that the rigors of critical thinking are what make an opinion reliable.

If you know of any appraiser continuing education specifically focused on critical thinking and real estate appraisal please let me know.

Dusty Little
Colorado Realty Reports

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