What Is An Evaluation Anyway?
Evaluations have been a hot topic for the last few years. Some financial institutions rely heavily on evaluations, while others hardly use them at all. Appraisal thresholds have been increasing, meaning that more and more loans qualify for an evaluation in lieu of an appraisal. Despite all the talk of thresholds, however, there is still a lot of confusion surrounding what an evaluation is. So, let’s start from the beginning.
Where did evaluations originate?
In response to the Savings and Loan Crisis of the 1980s, FIRREA (the Financial Institutions Reform, Recovery, and Enforcement Act of 1989) was passed. It instituted a process to require federal financial institutions to establish “appropriate” appraisal standards and to require the use of qualified (state certified and licensed) appraisers for federally related financial transactions. In response, the federal agencies (OCC, OTC, FRB, FDIC and NCUA) published a joint document called the “Interagency Appraisal and Evaluation Guidelines” (IAEG). The agencies did us all the favor of providing joint guidance instead of a plethora of different standards to keep up with. For that, we can be thankful.
What is an evaluation?
The IAEG set forth a list of requirements related to appraisals that also presented evaluations as an alternative, less stringent valuation product permissible in lieu of appraisals for lower risk transactions.
As defined by the IAEG, an evaluation can be either prepared by an individual or supported by an analytical method or technological tool, as long as it can be demonstrated that it provides a reliable estimate of the collateral’s market value. Some lending institutions use automated valuation models (AVMs) to satisfy the requirement for evaluations, especially for residential transactions. Others either have internal evaluators or hire third-parties for a more thorough look. The IAEG provide minimum evaluation content requirements, which I’ve abbreviated slightly below. Evaluations should:
identify the property location;
provide a property description along with its current and projected use;
provide an as-is estimate of the property’s market value, with any limiting conditions;
describe the methods used to confirm the property’s physical condition and the extent to which an inspection was performed;
describe the analysis that was performed and the supporting information that was used in valuing the property;
describe the supplemental information that was considered when using an analytical method or technological tool;
indicate all source(s) of information used in the analysis, as applicable; and
include information on the preparer when an evaluation is prepared by a person.
For clarity, the IAEG also specifically provide a few examples of what an evaluation cannot be, such as a broker price opinion (BPO) or a competitive market analysis (CMA). Those products do not meet the minimum requirements presented above.
The list of eight bullet points required for evaluations is a far cry from the 344 pages that make up the Uniform Standards of Professional Appraisal Practice (USPAP), which all appraisals supporting federally related transactions must comply with. Evaluations are a lot more concise than your average narrative appraisal, and the price generally reflects it, which is how they benefit lending institutions and consumers.
When can a lender rely on an evaluation in lieu of an appraisal?
The IAEG establish a list of exemptions, for which an evaluation is acceptable in lieu of an appraisal. These include:
Commercial real estate transactions less than $500,000 and residential real estate transactions less than $400,000
Business loans below $1,000,000 where the source of repayment is not dependent on the sale of, or rental income derived from, real estate
Renewals with no material changes in market conditions, property conditions or loan terms that “threaten the adequacy of the institution’s real estate collateral protection”
Although the guidelines above are fairly permissive, the IAEG also require that lending institutions establish risk-based procedures for escalating due diligence in higher risk transactions such as:
loans with combined loan-to-value (LTV) ratios in excess of the supervisory LTV limits;
atypical property types;
properties outside the institution’s traditional lending market;
renewals with significant risk to the institution; or
borrowers with high risk characteristics.
Some banks with lower risk tolerances implement more stringent guidelines and order appraisals even when evaluations are technically permissible according to the IAEG. Every institution’s internal policies and procedures are a bit different.
Can appraisers provide evaluations?
In short, yes, appraisers can provide evaluations. This is great news for consumers, as this means that they can get a valuation product from a valuation expert. However, most states have laws that require any valuation work completed by a state credentialed appraiser to comply with USPAP.
Most states don’t specifically exclude evaluations from this requirement, which creates confusion as to whether the product that can be provided is actually an appraisal or an evaluation. Depending on the state and the individual practitioner, appraisers have incorporated evaluations into their practices in many different ways, such as:
Appraisers in any state can provide a USPAP compliant restricted appraisal report that satisfies the requirements of an evaluation. Some appraisers choose to predominantly label these reports as evaluations, while others label them just as restricted appraisal reports.
Some states explicitly allow appraisers to provide evaluations, just as intended in the IAEG.
Some appraisers are comfortable enough with the gray area in the regulatory structure of their territory to provide evaluations as intended in the IAEG without an explicit allowance from their state to do so.
Some appraisal firms (and financial institutions) employ non-appraisers to write evaluations. USPAP requirements don’t apply to non-appraisers, so these professionals can provide evaluations just as intended in the IAEG.
In short, when there is a will, there is a way. Real estate appraisers are typically the most qualified individuals to perform or oversee evaluation services, and many are bringing their valuation expertise to this growing segment of the market.