Occasionally, Valuation Management Group will receive an inquiry about the approaches to value and when they are or are not applicable. As most industry participants know, there are three typical approaches to value in an appraisal report: Cost Approach, Sales Comparison Approach, and Income Approach, summarized as follows:
- Cost Approach – The current cost of reproducing or replacing a building, minus an estimate for depreciation, plus the value of the land (and entrepreneurial incentive, if applicable).
- Sales Comparison Approach – The value indicated by recent sales of comparable properties in the market.
- Income Approach – The value that the property’s net earning power will support.
USPAP requires that the appraiser perform all approaches that are found necessary for credible results by the appraiser. USPAP also requires that the appraiser explain and support the exclusion of any approach within the appraisal report. USPAP does not require the appraiser to exclude any approach that is believed to not be applicable by the appraiser. It is the appraiser’s job to determine the approaches and scope of work that are necessary for credible results, and to include the necessary reporting. Therefore, the client can engage a willing appraiser to complete any approach(es) the client desires to be performed, even if the appraiser believes that the requested approach(es) is/are not necessary for credible results.
For example, a client recently ordered a commercial appraisal of a 70+ year old retail row building on Main Street in a small town. The most typical purchaser would be an owner-user; therefore the Sales Comparison Approach was considered necessary for credible results. However, there existed a small possibility that a local investor would purchase the building for lease out. The Income Approach was also considered applicable, but wasn’t given full weight in the final value conclusion since that represented a very small pool of buyers. The Cost Approach would not typically be performed for this property type largely due to difficulty in accurately calculation a large degree of depreciation on a 70+ year old building. However, the client specifically desired to have the Cost Approach included in the report because their loan committee was interested in the separate allocation of value to land and building. The bid language that we assisted our client with specifically requested that the appraiser include the Cost Approach, regardless of whether the appraiser believed it to be necessary for credible results. In this case, the appraiser was able to give the client a credible report that relied solely upon the Sales Comparison Approach indication, slightly tempered by the Income Approach indication, and with no weight to the Cost Approach. In addition to having a reliable, credible value conclusion within the report, the client was able to answer the loan committee questions that were answered by the Cost Approach. This report was considered USPAP compliant, credible, and acceptable.
As our client’s trusted appraisal resource, we want to assist in the appraisal ordering process and ask questions in order to avoid pitfalls of time and/or money loss to our clients and panel appraisers. When a client places an appraisal order that says “use all three approaches” or “use the sales and income approach”, or any combination of approaches, etc., VMG’s Client Specialists make it a practice to ask why during the ordering process. Often times the person ordering the appraisal may ask for specific approaches out of habit rather than knowledge of USPAP or methodologies. A problem can arise when we review an appraisal report that has an engagement letter that asks for “all three approaches”, etc., but then an approach is omitted by the real estate appraiser. The report may be USPAP compliant because the appraiser has explained and supported the exclusion, but the Quality Assurance Reviewer is left wondering if the omitted approach is needed for some other reason of the client’s or if the client really meant what they asked for at the time of ordering. What if the client really paid for and needed the approach that was excluded? We cannot, in good faith, deliver the report to the client, and set into motion payment processing to an appraiser, when the client’s requested needs have not been met. But what if the client didn’t mean “all three approaches”, rather simply meant “all applicable” approaches? We are now holding up a report, and possibly a crucial closing for a client, when the report is USPAP compliant and credible as it is and may indeed meet the client’s request. Either way, VMG would prefer to stop and contact the client for clarification during the ordering process so that the review process is not delayed later. We also want to act as the appraiser’s advocate and ensure that the appraiser knows exactly what is needed during the bid process, thus resulting in time efficiency for the appraiser and the most reasonable, accurate fee.
Valuation Management Group is a national, full service appraisal management service company that manages the appraisal process, including the required review, for financial institutions, banks, mortgage bankers, and credit unions. We offer the full array of commercial and residential appraisal products and services, taking the appraisal process from ordinary to extraordinary.