ARM: Reviewer Independence When the Original Appraiser Is a Friend and Colleague
You are the review appraiser at a regional bank. A commercial real estate appraisal of a strip center comes in for review. The signing appraiser is a longtime friend and frequent panel appraiser; you have co-taught courses with him and he has referred work to you. The report has a supportable sales comparison approach but a thin income approach: the cap rate is stated without derivation, vacancy is set at 3% while the submarket shows 9%, and the concluded value is at the top of the range. The loan is large and time-sensitive. Your manager says 'just sign off, he's always been reliable.' The report otherwise complies with USPAP.
1. What are the independence and ethics issues, and what must you do?
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Independence (USPAP Ethics Rule / conduct) is compromised by the friendship, co-teaching, and referral relationship - these create a familiarity/self-interest threat. The manager's 'just sign off' pressure is improper influence. You must: (1) disclose the relationship and the pressure in the workfile and, if required, to the client; (2) either recuse or, if you proceed, document why the relationship does not affect your judgment and apply heightened scrutiny; (3) not let the relationship or the deadline change the review conclusion. Signing off on a thin income approach because 'he's reliable' is exactly the failure the review function exists to prevent.
2. Evaluate the income approach deficiencies on their merits, independent of the relationship.
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Three specific defects: (1) Cap rate without derivation - SR 3 review must test support; an unsupported rate is not credible, and the reviewer should require the derivation (market extraction, band of investment, or survey) or conclude the approach is not adequately supported. (2) Vacancy at 3% vs. submarket 9% - this materially overstates NOI and value; the report must justify why the subject would outperform a 9% submarket, or the assumption is unsupported. (3) Value at top of range - combined with the above, this suggests the conclusion was reverse-engineered. The sales comparison approach may still be supportable, but the overall value conclusion must be tested for credibility across approaches; if the income approach is materially wrong, the reconciliation must explain why the sales approach dominates or the value is not credible.
3. Draft your review conclusion and the documentation you would create.
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Conclusion: 'The sales comparison approach is adequately supported. The income approach is not credible as presented because the capitalization rate is underived and the vacancy assumption (3%) is materially below the submarket (9%) without justification; the value conclusion at the top of the range is therefore not adequately supported by the income approach. The reviewer does not concur that the overall value opinion is credible until the income approach is corrected or the reconciliation explains why it should be given no weight.' Documentation: (1) memo disclosing the friendship/referral relationship and the manager's pressure, (2) the specific deficiency findings with page cites, (3) a written request to the original appraiser for the cap-rate derivation and vacancy support, and (4) a record of the manager's instruction and your response. This satisfies SR 3 and protects both you and the bank.