Yes, it is time for appraisers to grow a pair. Now, before you get all nervous at this potential physical impossibility for some of us, understand I’m referring to a pair of models of thinking about how we analyze real estate. Those two models commonly carry the terms of critical thinking and systemic thinking. That pair is necessary to success as a real estate appraiser. After all, are we not really real estate market analysts? Do we not analyze real estate markets in order to form an opinion about the value of a specific property, at a specific time, in a specific neighborhood or market area, under as specific set of market conditions? Yes, that’s exactly what we do, so it’s time we grew a pair – a pair of thinking and analytical models to make us better analysts and appraisers.
Here’s one definition of Critical Thinking : “A disciplined thinking that is clear, rational, open-minded, and informed by evidence”. To discipline means to train or develop by instruction and exercise. Rational means something that has it’s base in accordance with reason or logic. It is something related to, based on, or guided by reason principle, fairness, logic, a legitimate interest, or a consideration of fact. Open-minded connotes someone who is willing to consider new ideas, as well as someone who can make judgments without prejudice. Finally, evidence means the available body of facts or information indicating whether a belief or proposition is true or valid; or something that ascertains the proof of a matter”.
Another definition teaches us that Critical Thinking is “…the application of logical principles, rigorous standards of evidence, and careful reasoning to the analysis and discussion of claims, beliefs, and issues. As components of the definition, rigorous means extremely thorough, exhaustive, or accurate (as in proper due diligence). The same source indicates the process of Critical Thinking is “…associated with accuracy, logic, depth, fairness, credibility and intellectual clarity…”. It means that one does not accept automatically accept the validity or accuracy of the information s/he is given.
Both the USPAP document and the Fannie Mae Selling Guide (FMSG) reference due diligence, or its synonym, due care, though neither source defines the terms. Therefore, it makes sense to ascertain what these documents say on this important component of Critical Thinking. The COMPETENCY RULE admonishes appraisers to use due diligence and due care to avoid rendering appraisal services in a careless or negligent manner. Then, in AO-22, USPAP teaches that the appraiser must ensure to research the sales history of the subject “…to obtain relevant information about current and recent market activity regarding the subject…[t]his due diligence effort…serves as a safeguard against confusing the price…with market value and is a safeguard against the appraiser being inadvertently involved in an effort to conceal the facts in regard to …recent sale[s] transactions” (ibid – emphasis added).
In AO-24, USPAP goes on to instruct that “…[the] analysis that [SR1-5 requires] promotes a certain degree of due diligence on the part of the appraiser. Appropriate due diligence increases public trust in the appraisal profession” (ibid – emphasis added).
Finally, USPAP’s FAQ #181, in the context of measuring the square footage of a property, makes it clear that “…[a]ppraisers must use due diligence and due care in performing appraisal services…” (ibid – emphasis added).
On the other hand, there is only one relevant reference to appraiser due diligence in the FMSG. This is in Section B4-1.3-12, Quality Assurance (01/30/2018), Changes to the Appraised Value. It warns lenders (not appraisers) that they “…must pay particular attention and institute extra due diligence for those loans in which the appraised value is believed to be excessive or when the value of the property has experienced significant appreciation in a short time period since the prior sale” (ibid).
Now, how does USPAP foster a spirit of critical thinking in appraisers? First, consider the definition of an appraisal. In short, it is the process thru which an appraiser goes to conclude a credible value opinion. Congruent with this is USPAP’s SR1-4 which teaches this process (i.e., developing a credible value conclusion) involves the appraiser in collecting, verifying, and analyzing “…all information necessary for credible assignment results…” (ibid – emphasis added). Thus, this three-step sub-process involves the due diligence to collect, verify, and analyze all the necessary data, rather than merely the data it is easy to collect.
Next, look at USPAP’s definition of an appraiser, who the public expects “…to provide valuation services competently, and in a manner that is independent, impartial, and objective…” (ibid). It is clear from these definitions of critical thinking that all four of the characteristics of an appraiser are components of those two definitions. How is this so?
Consider the concept of rigorous. Per our definition it implies due diligence in that SR1-4 calls for the appraiser to collect, etc. all of the necessary information. This requires a rigorous search, which is a function of the due diligence necessary to understand a particular market. Considered the concept of open-minded. Compare this with the definition of an appraiser, which requires a spirit of independence, impartiality, and objectivity. The appraisal process requires the appraiser to analyze the subject and its relevant market(s) with an open mind so as not to depend on what others tell the appraiser (in the hopes of influencing him/her, as our friends in the brokerage community are wont to do).
Along these lines, if an appraiser thinks critically, if the evidence of what the sales and listing data lead the appraiser to conclude inform the appraiser’s analyses and conclusions, then the appraiser cannot help but be independent, impartial, and objective. And how about the concept of accuracy as a component of critical thinking? True, there is no such thing as an accurate appraisal since an appraisal is merely an opinion. However, there is accuracy in measuring the subject. There is accuracy in deducing adjustments. There is accuracy in reading market trends. There is accuracy in deducing the boundaries of the subject’s market area. Therefore, while an appraisal itself cannot be accurate (how do you measure the accuracy of an opinion?), the data and the analyses that go into that opinion must be the result of accurate analyses of those data.
Therefore, it is clear that USPAP not only encourages critical thinking from the appraiser; indeed, it demands that appraiser’s critical thinking.
As a complement to critical thinking is systemic (or systematic, or systems) thinking. This part of the appraisal process means “…thinking that is a holistic approach to analysis that focuses on the way that a system’s constituent parts interrelate and how systems work over [the passage of] time…within the context of larger systems . Holistic means “relating to the idea things should be studied as a whole and not just as a sum of their parts (ibid). In other words, the whole is more than the sum of its components.
Now let’s consider an example of critical thinking. You’re appraising a 25-year old house. There is nothing either particularly positive or negative about this neighborhood-typical property. As part of the cost approach, you look up depreciation on a pre-printed depreciation table and then deduct that ratio from your calculated cost new. Standard operating procedure, right? You’ve been doing this for 25-plus years. This is what your mentor taught you. But if critical thinking does not allow you room to take somebody’s word on this, if you uncritically accept that source’s statement of depreciation (supra), have you engaged in critical thinking? This is not to accuse the source of that depreciation ratio of being wrong or having calculated that ratio poorly. It is, rather, to ask yourself if you have engaged in the proper due diligence to examine it critically.
After all, when you make the statement that your 25-year old house has, say, 37% accrued depreciation, you have just made a statement of fact since it is something you can extract from the market, thus is measurable as a matter of fact. Per USPAP SR2-3, you certify that all statements of fact in a report are both true and correct. There is nothing wrong, per se, with using only the depreciation ratio from the pre-printed chart. Nevertheless, when you extract depreciation from the market, you have the opportunity to exercise the due diligence to support it from two sources. Your analysis of depreciation is not merely from national data. Rather, you extracted it from sales data in the subject’s own market. What could be more independent, impartial, and objective than taking that information from the market?
Now, on to systemic thinking. It is too easy to consider an appraisal and its attendant report to be merely an agglomeration of facts resulting in conclusions – since, in essence, that is just what appraisals are. However, our challenge, the systemic thinking challenge, is to turn this agglomeration into an organic whole that persuades the client and intended users to conclude as we did when it comes to value, highest and best use, the selection of comps, and so forth. How do we achieve this objective?
Sticking with the example of extracting depreciation from the market, we now can:
Conclude and explain if the subject’s neighborhood suffers from an external obsolescence factor (i.e., is depreciation here any higher than it would have been otherwise?)
Conclude and explain if the subject is depreciating any faster (or slower) than it would otherwise (although this ratio in and of itself would likely not explain why that was so)
As part of highest and best use, determine and explain if the subject improvements should be left alone, repaired/renovated/remodeled, or razed
Use the market-derived depreciation ratio in the sales comparison approach as the source of the age & condition adjustment(s), as well as the basis of that adjustment’s explanation
Use the market-derived depreciation ratio in the sales comparison and income approaches to determine and explain if there is any functional obsolescence – superadequacy
So, literally, the concept of depreciation is an important and major component not only of the Cost approach, but of the Sales Comparison and Income approaches as well. This illustrates both that, how, and why the appraisal and report are an organic whole, rather than merely an agglomeration of related facts. One of the reasons lenders like AVMs so much is that they make clear why what’s on the page is on the page. Sometimes, however, that is not clear with an appraisal report since, so many times, it presents merely facts but not their interpretation, nor why they are an important part of the value conclusion. There is no attempt to relate them to each other, nor to the final value opinion. Why is this so? How does this lack of an attempt to unify our analyses with our value conclusion benefit us and/or the client? How does it make what we sell superior to what an AVM provides?
We appraisers and our clients benefit when we think critically. We and they benefit when we make it clear our analyses come from market data we have properly verified and analyzed. We have not taken the broker’s word for, say, the subject’s square footage, since we measured it ourselves. We have not merely taken the listing agent’s word that the sales price was $350,000 since we also pulled the deed and spoke with the selling broker. Our age and condition adjustment has its base in depreciation data from not only a national costing service, but from market extraction as well. On other words, we have not taken anybody’s word for anything. Independently, impartially, and objectively we either derived the data ourselves, or we verified those data personally. Thus, because of our own efforts, our own due diligence, we know those statements of fact are true and correct.
We appraisers benefit when we think systemically, too. Since the generic, trite, boilerplate phrase, “The adjustments to the comparable sales are as shown” means nothing (and makes the author sound stupid [if not downright incompetent – if they are other than as shown, why does the report show the wrong ones?]), we avoid that by writing systemically, too. For example, consider this summary of the adjustments the appraiser made/did not make as part of the sales comparison approach.
“The report shows adjustments to the comparables for location, site size/corner location, and square footage differences. The location difference has its base in a comparison of vacant land sales within the subject’s neighborhood versus sales in a similar but generally inferior neighborhood (due to its location proximate to a major freeway interchange).
“Comparable sale #2 is a full corner, while the subject is an interior site. Sale #2 sold for slightly more than other sales in the neighborhood, thus the appraiser, as a judgment call within the scope of work, attributed that difference to the corner/site size influence.
“Finally, a comparison of the sales of smaller houses, with the sales of larger houses, after accounting for differences in site values, indicated larger houses sold, generally, for about $25 per square foot less than smaller homes. In addition to this analysis, the appraiser also analyzed the price-per-square-foot differences between the cost of smaller houses of similar Q and C to the subject with those of larger houses. The difference was larger than $25 per square foot, but that analysis did not account for diminution in value from accrued depreciation.
“Thus, two reliable sources of data support the appraiser’s conclusion of a size adjustment. Given this support, the appraiser also concluded the market data merited more weight than the more generic national cost data.
“Since the market did not give any reliable indications that other differences merited adjustments, the appraiser, in listening to the market speak, chose not to make any more adjustments.”
Now, consider the following highest and best use statement. It clearly considers both the four-step analytical process from the 14th ed. of The Appraisal of Real Estate, as well as the Fannie Mae model. It also considers, albeit tangentially, the highest and best use factors in SR1-3(a), USPAP’s highest and best use Standards Rule:
“That development of the subject site with a single-family residence is clear since those are what improve the surrounding sites in the subject’s neighborhood. The subject site’s size, shape, frontage, depth, topography, terrain, access and drainage are such that physical development is not only possible but, given the demand for houses in this neighborhood (see the 1004MC form for a summary of supply and demand factors), development is likely. Thus, development of the site with a single-family residence is a physically possible use.
“Given the subject site’s R-1 zoning, and its emphasis on single-family houses (to the exclusion of condos, townhouses, apartments, and so forth), then development with a single-family residence is not only a physically possible use, that is also a legally permissible use (so long as any such development stays within the land-to-building ratio limits, etc. set forth in the zoning [by reference]).
“While the subject site is not vacant as of the appraisal’s effective date (see subject photos), the appraiser concluded that it was necessary to form a value conclusion as if the site were vacant (see land sales summary data here by reference). This conclusion is part of both the cost approach as well as of the sales comparison approach. It is a part of the cost approach since a vacant site value is a line-item inclusion in concluding the subject’s value via the analyses inherent in that approach. It is a component of the sales comparison approach in that, without the conclusion, it would be impossible to adjust for the differences in value between the subject site and the those of the comparable sites.
“Since there are both horizontal and vertical improvements at the subject site as of the effective date of the appraisal, there was no need to conclude if the construction of the subject’s improvements were financially feasible. It was, however, necessary to conclude if the present improvements should undergo renovation/restoration/remodeling/repair, or to be left alone.
“Currently, in the subject’s market area, there are no signs of owners razing improvements to access the site to develop it to its highest and best use, so there is no indication of land uses changing. There is no evidence of owners extensively rehabilitating or renovating properties, thus the physical adaptability of residential use to another use is not currently a market issue. There is evidence of homeowners completing deferred maintenance, as well as other maintenance and repair items. Further, there is market evidence new buyers here remodel the interiors of their properties after close of escrow. However, this is relatively low-level, such as repainting, replacing appliances and/or flooring, new landscaping, and so forth. These market data indicate but typical post-purchase modernization to houses.
“Therefore, to purchase the subject for its current market value, raze the horizontal and vertical improvements, build a new house, and then try to sell it at a profit sufficient to make those steps financially feasible is a step the market is not currently making. Therefore, the subject’s financial feasibility lies in its present improvements as of the appraisal’s effective date, rather than in some other use.
“Further, using the value indications from both the cost and sales comparison approaches (by reference) demonstrates the present improvements contribute at least one net dollar to the value of the underlying site as if it were vacant (which it currently is not).
“From the market evidence this appraisal report summarizes, it is clear the market currently indicates the highest and best use of the subject as improved is in its present improvements.
This language ties the highest and best use analysis to data and conclusions from throughout the appraisal report. This is basically what “holistic” as a part of the definition of systemic thinking means. It is too easy to let an appraisal report remain merely an aggregation of facts. The language above (and in the highest and best use analysis) ties the disparate elements of the appraisal’s analyses into an entity that makes more sense than it would if it were to remain in its separate elements.
See? It’s time appraisers grew a pair to become better appraisers and analysts. That pair is the combination of systemic thinking and critical thinking. We need to grow that pair to make sure clients need and want us and the services we provide for a fair fee, but not the services of an AVM or an evaluation. Granted, the AVM and the evaluation are cheaper. But, don’t you get what you pay for?
If I can ever help you with a USPAP- or an appraisal-related issue, feel free to contact me, Tim Andersen, at tim@theappraisersadvocate.com. It will be an honor to work with you!