ÀÖ¾ºÌåÓýÈ«Õ¾

An Advisory from the Colorado Division of Real Estate

ÀÖ¾ºÌåÓýÈ«Õ¾ Division conducts a significant amount of work product reviews every year through investigations and licensure applications. As part of the Division’s effort to better achieve compliance with frequently violated rules and for more meaningful communication, this series has been developed for licensed appraisers and covers the most common appraisal issues seen by the Division.

Understanding Scope of Work

Understanding Appraiser Workfile Requirements

ÀÖ¾ºÌåÓýÈ«Õ¾ Sale Comparison Approach 

Cost Approach to Determine Value

Identify the necessary elements of the appraisal assignment as per USPAP; what is acceptable to produce credible results; limiting conditions and disclosures; and common issues encountered when developing assignment results.

What rule of the Uniform Standards of Professional Appraisal Practice (“USPAP�) has a common frequency of noncompliance?

It is the Scope of Work Rule. ÀÖ¾ºÌåÓýÈ«Õ¾ Division of Real Estate ("the Division") routinely investigates complaints that result in non-compliance with the Scope of Work Rule of USPAP. ÀÖ¾ºÌåÓýÈ«Õ¾ Board of Real Estate Appraisers ("the Board") and the Division want to achieve better compliance with this rule so that credible assignment results can be accomplished for the public.

Scope of Work Requirements

An appraiser must establish the appropriate scope of work necessary to complete an assignment.

Identify the problem to be solved by gathering the necessary information.

An appraiser must identify the following elements of the assignment as per USPAP:

• Client and any intended users;
• Intended use of the appraiser’s opinions and conclusions;
• Type and definition of value;
• Effective date of the appraiser’s opinions and conclusions;
• Subject of the assignment and its relevant characteristics; and
• Assignment conditions.

Determine and perform the scope of work necessary to produce credible results.

ÀÖ¾ºÌåÓýÈ«Õ¾ scope of work is acceptable when it meets or exceeds:

• ÀÖ¾ºÌåÓýÈ«Õ¾ expectations of parties who are regularly intended users for similar assignments; and
• What an appraiser’s peersâ€� actions would be in performing the same or similar assignment.

Do not limit the scope of work if it leads to non-credible assignment results.

If the conditions limit research opportunities into relevant information that is necessary to produce credible results in the context of the intended use, the appraiser must withdraw from the assignment UNLESS the appraiser can:

• Modify the assignment conditions to expand the scope of work to include gathering the information; or
• Use an extraordinary assumption about such information, IF credible assignment results can still be developed.
• Remember: Lack of competency does not mean you can limit the scope of work.

Disclose Scope of Work in the Report

What are some common issues?

• Unfamiliarity with the property type (condo, manufactured home, land, commercial) can lead to insufficient scope of work and non-credible assignment results.
• Appraiser must determine the scope of work needed to develop credible assignment results within the context of the intended use.
• If a client prohibits expansion of scope of work that is needed, the appraiser must decline the assignment.
• Not using the correct definition of market value, or including multiple definitions of market value. You must only include that definition of value which pertains to the assignment.
• ÀÖ¾ºÌåÓýÈ«Õ¾re is not enough analysis disclosed in terms of adjustment support, cost analysis, and income resources.
• Inclusion of boilerplate information does not constitute scope of work disclosure. Example: “Adjustments are supported by one of the followingâ€�.â€�. “Land value included is supported by land sales, allocation or Extraction…â€� Scope of Work Rule requires that you discuss the information pertinent to that specific appraisal.
• One of the tests of acceptability is by judging the actions of an appraiser’s peers. This pertains more to methodology than using the conclusions of your peers.
• This also applies to percentages, cost figures, and the use of a cost approach itself. Remember to always use *your own* market analysis and support for all appraisal conclusions.

What are some possible violations?

• Failure to comply with the Scope of Work Rule will result in discipline for violating it and the Competency Rule and Standards Rules.
• Violation of the Ethics Rule is also possible depending on the severity of the violations.

Conclusion

ÀÖ¾ºÌåÓýÈ«Õ¾ scope of work carries with it the burden of proof to support conclusions. Appraisers cannot meet their obligations in a market value assignment without having competently identified and then completed a scope of work that enables development of credible opinions and conclusions. (USPAP Advisory Opinion 22)

Resources

An appraiser must prepare a workfile for each appraisal or appraisal review assignment in order to be compliant with the Record-Keeping Rule.

What rule of the Uniform Standards of Professional Appraisal Practice (“USPAP�) has the greatest frequency of noncompliance?

It is the Record Keeping Rule. Roughly 48% of the complaints investigated by the Division of Real Estate ("the Division") are non-compliant with the Record Keeping Rule of USPAP. ÀÖ¾ºÌåÓýÈ«Õ¾ Board of Real Estate Appraisers ("the Board") and the Division want to achieve better compliance with the Record Keeping Rule.

Workfile Requirements

An appraiser must prepare a workfile for each appraisal or appraisal review assignment.

Preparation of the Workfile. 

• An appraiser should not wait to prepare a workfile upon receiving the notification by the Division that a complaint has been filed against their license. 

• ÀÖ¾ºÌåÓýÈ«Õ¾ workfile must be in existence prior to the issuance of any report or other communication of assignment results.

• For an oral report, a written summary must be added to the workfile within a reasonable time after the issuance of the oral report.

Contents of a Workfile. To be compliant with the Record Keeping Rule, the workfile must include:

• ÀÖ¾ºÌåÓýÈ«Õ¾ name of the client and identity, by either name or type, of any other intended user;
• True copies of all written reports;
• If relevant, summaries of all oral reports or testimony (or transcript of the testimony) including the appraiser’s signed and dated certification; and
• All data, information, and documentation that are necessary to support the appraiser’s opinions and conclusions or references to the location of such data, information, or documentation.

Data, Information, and Documentation Examples. ÀÖ¾ºÌåÓýÈ«Õ¾ list below is by no means an exhaustive list but is meant to provide illustrations of standard data, information, and documentation included in the workfile:

• Any data regarding the Subject
• Any paired sale analysis
• Notes from the Discussion with any Real Estate Professional
• Details of Comparable Sales
• Any Building Plans
• Any Cost Data
• Any Data Considered but not Used

For Restricted Appraisal Reports and Oral Appraisal Reports, the workfile must include sufficient information, data or documentation for the appraiser to produce the appraisal report. It must also include a signed and dated certification.

Retention Period of the Workfile

Workfiles must be retained for at least 5 years or 2 years after the final deposition of any judicial proceeding in which the appraiser provided testimony related to the assignment, whichever period expires later.

Avoid Common Workfile Mistakes

To be compliant with the Record Keeping Rule of USPAP, an appraiser should avoid committing these common mistakes:

• Workfile has missing data or documents necessary to support the appraiser’s opinions and conclusions;
• Workfile is prepared after the assignment is completed or upon notification of a complaint sent by the Division;
• Data is stored in a location that is not retrievable during the retention period;
• ÀÖ¾ºÌåÓýÈ«Õ¾re is no workfile for canceled assignments; and
• ÀÖ¾ºÌåÓýÈ«Õ¾ signed and dated certification is missing.

Noncompliance with Record Keeping Rule

Failure to be compliant with the Record Keeping Rule may result in discipline from possible violations of the Record Keeping Rule and the Ethics Rule of USPAP.

Resources

Ensure a successful appraisal for your client by supporting adjustments properly, and learn what is not considered adjustment support.

What method is used to support your appraisal adjustments?

It is the Sales Comparison Approach. ÀÖ¾ºÌåÓýÈ«Õ¾ Division routinely investigates complaints that result in improper adjustments when determining value in an appraisal. ÀÖ¾ºÌåÓýÈ«Õ¾ Board and the Division want to achieve better results by appraisers using this approach so that credible assignment results can be accomplished for the public.

Definition of the Sales Comparison Approach

ÀÖ¾ºÌåÓýÈ«Õ¾ Sales Comparison Approach is the process of deriving a value indication for the subject property by comparing sales of similar properties to the property being appraised, identifying appropriate units of comparison, and making adjustments to the sale prices (or unit prices, as appropriate) of the comparable properties based on relevant, market-derived elements of comparison. ÀÖ¾ºÌåÓýÈ«Õ¾ sales comparison approach may be used to value improved properties, vacant land, or land being considered as though vacant when an adequate supply of comparable sales is available (ÀÖ¾ºÌåÓýÈ«Õ¾ Dictionary of Real Estate Appraisal, 6th Edition, Appraisal Institute).

USPAP Requirements

In developing a real property appraisal, an appraiser must collect, verify, and analyze all information necessary for credible assignment results (USPAP Standards Rule 1-4). When a sales comparison approach is necessary for credible assignment results, an appraiser must analyze such comparable sales data as are available to indicate a value conclusion (USPAP Standards Rule 1-4(a)).

USPAP Standards Rule 2-2 states, in part, “ÀÖ¾ºÌåÓýÈ«Õ� report content and level of information requirements in this Standards Rule are minimums for each type of report. An appraiser must supplement a report form, when necessary, to ensure that any intended user of the appraisal is not misled and that the report complies with the applicable content requirements.â€�

This includes summarizing the scope of work used to develop the appraisal, and disclosure of research and analyses both performed and not performed (USPAP Standards Rule 2-2(viii)).

Sufficient information must be provided to indicate that the appraiser complied with the requirements of Standard 1 by summarizing the information analyzed and the reasoning that supports the analyses, opinions, and conclusions, including reconciliation of the data and approaches (USPAP Standards Rule 2-2(x)(5)).

Scope of Work and Adjustment Support

ÀÖ¾ºÌåÓýÈ«Õ¾ report must contain sufficient information to allow the client and other intended users to understand the scope of work performed. ÀÖ¾ºÌåÓýÈ«Õ¾ information disclosed must be appropriate for the intended use of the assignment results.

Sufficient information includes disclosure of research and analysis performed and disclosure of relevant research and analysis not performed.

Types of Analysis Used in the Sales Comparison Approach

Common Techniques used to Support Adjustments Quantitative and Qualitative

ÀÖ¾ºÌåÓýÈ«Õ¾ following techniques should have sufficient data for support.

• Paired Sales Analysis
• Group Sales Analysis
• Regression Analysis
• Cost Analysis - Consider all different type of depreciation.
• Income Analysis - Use of GRM may be useful.
• Bracketing
• Buyer Interviews - Include documentation of conversation(s).
• Sensitivity Analysis - Adjustments moving based on results. This is a form of qualitative analysis based on a quantitative result and typically requires an additional explanation.
• Ratio - Used most often for GLA adjustments, based on the portion of the sale price that represents the GLA. Must have support for the ratio used.
• Use of Regression or Other Software - Remember that appraisers are responsible for the inputs, understanding how the data is synthesized, the degree of accuracy, and relevance to the analysis.

Common Issues with Adjustment Support

• Using generic boilerplate language to describe adjustment support. For example - “Adjustments were determined with paired sales analysis, regression, or discussions with market participantsâ€�. This results in a scope of work violation because the specific techniques were not discussed in the report. This could be more serious if none of this supporting documentation is located within the work file.

• Using predetermined adjustments. Generic adjustments used over and over despite the contradictory market data are easy to spot.

• Using cost data. Cost data may skew results since it is not a measure of market reaction. Some cost items may not contribute significantly to value. Remember: Cost does not always equal value! When cost data is used to support adjustments, but no cost approach is employed due to “insufficient cost dataâ€� or due to difficulty determining depreciation because the improvements are too old, the appraisal may appear to be inconsistent, resulting in the absence of the cost approach being unsupported.

Using average values instead of comparing sales to find the differences. Averaging a contributory value of an element of comparison and using that as an adjustment can cause skewed results. An adjustment is meant to measure the difference due to a difference between sales.

Adjusting within the direct sales comparison grid and then manipulating adjustments to make the range tighter can result in accusations of predetermined values.

One of the tests of acceptability is by judging the actions of an appraiser’s peers. However, it is important to use caution when using this as defense. A peer appraiser might use a $2,500 adjustment per bedroom which may not have been correct, which does not mean you should use the same adjustment within your analysis! “Actions of peers� pertains more to methodology than copying their conclusions. This also applies to percentages used to extract adjustments. Remember to always use market analysis and support for all appraisal conclusions.

Some appraisal software uses appraiser surveys as support for an adjustment. This type of information should be used with caution as the source of the data and sources of the survey may not be known. Such surveys may also be based on national surveys and may not apply to the local market.

Possible Violations/Outcomes

Failure to sufficiently support adjustments may result in discipline from violation of the Scope of Work Rule, Competency Rule, Standards 1, 2, and/or 3 and 4. 

Violation of the Ethics Rule is also possible depending on the severity of the violations. Ethics Rule violations are serious.

Conclusion

• Always provide sufficient adjustment support.
• Recognize your obligations - ÀÖ¾ºÌåÓýÈ«Õ¾ scope of work carries with it the burden of proof to support conclusions. Appraisers cannot meet their obligations with a market value assignment without having competently identified and completed a scope of work that enables development of credible opinions and conclusions (USPAP Advisory Opinion 22).
• Perform with compliance in mind. ÀÖ¾ºÌåÓýÈ«Õ¾ assignment elements necessary for problem identification in an appraisal assignment also serve as reference points in determining whether the scope of work performed was appropriate to provide credible assignment results.

Resources

Achieve better results when using this valuation approach so that credible assignment results can be accomplished for the public.

Which one of the three approaches to value used in a real estate appraisal is a common source of complaints against an appraiser?

It is the Cost Approach. ÀÖ¾ºÌåÓýÈ«Õ¾ Division routinely investigates complaints that result in the improper use of the cost approach when determining value in an appraisal. ÀÖ¾ºÌåÓýÈ«Õ¾ Board and the Division want to achieve better results by appraisers using this valuation approach so that credible assignment results can be accomplished for the public.

Definition of Cost Approach

• ÀÖ¾ºÌåÓýÈ«Õ¾ cost approach is a set of procedures through which value indication is derived for the fee simple estate by estimating the current cost to construct a reproduction of (or replacement for) the existing structure, including an entrepreneurial incentive or profit deducting depreciation from the total cost; and adding the estimated land value. Adjustments may then be made to the indicated value of the fee simple estate in the subject property to reflect the value of the property interest being appraised. (Source: ÀÖ¾ºÌåÓýÈ«Õ¾ Dictionary of Real Estate Appraisal; 6th Edition, Appraisal Institute)

When the cost approach is necessary for credible assignment results, the appraiser must:

• develop an opinion of site value by an appropriate appraisal method or technique;

• analyze such comparable cost data as are available to estimate the cost new of the improvements (if any); and

• analyze such comparable data as are available to estimate the difference between the cost new and the present worth of the improvements (accrued depreciation) (See USPAP Standards Rule 1-4(b).

Determining value by the cost approach

Improvement Replacement Cost

Resources may include:

• Builder estimates and costs
• Marshall & Swift
• All cost resources must be documented

Depreciation Types

• Physical
• Functional
• External Obsolescence

Contributory Value of Improvements = Replacement Cost - Depreciation

Why use the cost approach?

ÀÖ¾ºÌåÓýÈ«Õ¾ cost approach is a recognized technique to determine value.

When is it most appropriate to use the cost approach?

• New and proposed construction
• Special purpose properties (eg. churches, golf courses, etc.)
• Situations where there is little or no market activity

Benefits of the Cost Approach

• ÀÖ¾ºÌåÓýÈ«Õ¾ cost approach is an integral component of the principle of "substitution", and serves as a “checkâ€� against the sales comparison approach.
• A skewed result from the cost approach may point towards functional or external obsolescence.
• Can help identify a potential runaway market or a rapidly declining market.
• A knowledgeable buyer will pay no more for a home “than it would cost to buy a similar land and erect a similar structure without undue delay.â€�
• May raise a red flag in cases of under-valuation in short-sale fraud, or overvaluation in mortgage fraud.

A supported cost approach can result in a better appraisal.

• Document all sources of cost data and calculations.
• Reconcile your value indications from various sources and retain your data and analysis in the workfile.

When is the cost approach not appropriate to use?

• Significantly older improvements may make depreciation difficult to accurately estimate.
• Effective age is a good indicator as to whether cost approach is appropriate.
• When improvements do not represent the highest and best use of the land as though vacant.
• When relevant comparable cost data is lacking or too diverse to indicate entrepreneurial profit.
• In an appraisal for investment purposes, it is not appropriate since the time to develop and construct must be considered.

Common issues seen in the cost approach

• Cost approach not developed properly (fabrication of cost data).
• Unfamiliarity with cost manuals.
• Inapplicable and/or unsupported “canned commentsâ€� such as: “Cost approach is irrelevantâ€�; “Costs are not accurateâ€�; “Not applicable as an indicator to valueâ€�; or “Not requiredâ€�.
• Just because the cost approach isn’t required, does not mean that it can’t be performed, or shouldn’t.
• No support for: Replacement costs; Economic life and effective age; or Site value estimate.

Possible violations/outcomes

• Failure to apply a supported cost approach may result in discipline from violation of the Scope of Work Rule, Competency Rule, Standards 1 and 2.
• Failure to include the cost approach when it is applicable may result in violation of Standards Rule 1-4 and 2-2.

Conclusion

If the cost approach is applicable, ensure that it is performed correctly with credible support for conclusions relating to site value, effective age, cost data, and depreciation. Never use inapplicable “canned comments� that are not supported by market data.

Resources