The Mystery of the Hypothetical Condition

This is Diana with ABC-The Appraiser’s Business Companion.  The Hypothetical Condition has been around for many years as has the Extraordinary Assumption.  Even so, the differences between the two and when to use one or the other is still a mystery to many.   A brief history of those two terms is in order.

In the early years of our Uniform Standards of Professional Appraisal Practice (USPAP), specifically 1987, did you know there was no “Ethics Rule”?  In fact, the opening rules were called “Provisions”.  That edition also had definitions but Hypothetical Condition and Extraordinary Assumption was not in the Definitions section of the document.  On January 30, 1989 the Appraisal Standards Board (ASB), unanimously approved and adopted the original Uniform Standards as the initial standards.  It wasn’t until December 4, 1989 the ASB added the Ethics Provision.  The 1990 edition of USPAP was published in April 1990 as the preceding version ran from December 4, 1989 through April 20, 1990.  It was in that edition the words “Hypothetical Condition” appeared in the Ethics Provision.

Here’s how it read, “Conduct Section-“An appraiser must perform ethically and competently in accordance with these standards and not engage in conduct that is unlawful, unethical, or improper.  An appraiser who would reasonably be perceived to act as a disinterested third party in rendering an unbiased appraisal, review or consulting service must perform assignments with impartiality, objectively, and independent and without accommodation of personal interest.”  In the comment section it stated in the second paragraph of the comment section, “The development of an appraisal, review, or consulting service based on a hypothetical condition is unethical unless: 1) the use of the hypothesis is clearly disclosed; 2) the assumption of the hypothetical condition is clearly required for legal purposes, for purposes of reasonable analysis, or for purposes of comparison and would not be misleading; and 3) the report clearly describes the rationale for this assumption, the nature of the hypothetical condition and its effect on the results of the appraisal review, or consulting service.  No where in that early edition did the words/terms “hypothetical condition” or “extraordinary assumption” were those phrases even explained.  This directive was not only not defined only the term Extraordinary Assumption was seen until Standard 2 and it was Standard Rule (SR) 2-1 (c) (this SR is now a directive of an ethical pre-requisite when reporting a real property appraisal).  Subsequent editions found the two terms Extraordinary Assumption and Hypothetical Condition to be in the Definition sections and in the Development and the Reporting Standards of a greater specificity in the appraisal process.  What is a Hypothetical Condition?  How would you explain the use in your Appraisal Report?

In plain and simple words, a Hypothetical Condition-is just a “bald-face lie”.  Umhmm, that’s what I said, it’s a “bald-face lie”.  In pretty words, professionally stated, it is a known false condition.  You knew it wasn’t true when you said it.  Now here’s the confusing part, when would it be ethical to lie?  Get ready, we’re going in to get a little tangled here, what do you know about telling a lie?  In general, you are lying when you don’t want the truth to be known for any myriad of reasons.  This is why we have such a struggle with hypothetical conditions as appraisers.  A lie is intentionally told for the purpose of misrepresenting the truth.  Hypothetical conditions are not false statements made in secret nor are they intended to mislead.  Hypothetical conditions are boldly stated, made clear and made known that what is being assumed is not, on that effective date, actually true.  Everyone who is impacted by that appraisal (client’s and intended users) knows the condition is not true.

A hypothetical condition is a disclosure upfront with clear intent.  If you were in a conversation you may say, “lets pretend” the house is already built.  A hypothetical condition is stated clearly and concurrently, at the time of the reporting, is reasonable to pretend the property is hypothetically improved.  In order to do so, the hypothetical condition has to be legal in nature to assume.  That can often be a bit difficult because sometimes we’re asked to appraise under a hypothetical condition that zoning will be changed or spot zoning will be allowed.  How is that gray situation considered reasonable when legally it simply isn’t so?

Often zoning changes are considered for not only entire areas but also for “spot zoning”, it’s a variance that is granted and makes a specific use legal.  Those are reasonable considerations and with disclosure could be performed under a hypothetical condition.  Another example would be a manufactured home being wheeled onto the site is still personal property but with permission from the local authority may be converted into real property.  Its known as an act of annexation.  The legal process generally requires the traveling gear is removed, foundation is properly prepared in accordance with local authorities and the property is properly strapped and pinned both with local authorities’ directives, considerate of the wind zone.  The process also requires a recorded legal act of annexation, which then converts the personal to real.  Each jurisdiction has their own expectations but the process is similar across the country.  Find out your location and legal processes, if it seems reasonable then yes, under a hypothetical condition this can be appraised as if it were real property.

Its important to distinguish a reasonable occurrence from one that is not legally probable.  When a client states for example, they want a house that has been retrofitted to be a senior care facility and is leased for greater than one year but the owner wants a home equity loan then “no” the consideration of the subject dwelling to be a dwelling isn’t legally probable near the effective date.  Think about it, the lease would have to be dissolved.  The occupants who’ve signed a contract to live in that dwelling and be assisted in their care would have to be relocated with the agreement of the occupants.  The retrofitting would have to be returned to its single-family dwelling status, cabinets with locks would have to be restored, the commercial kitchen may require being retrofitted.  In these situations, it’s always a good idea to not rely solely on the electronic communication; a diligent appraiser faced with challenging requests for assignments under a hypothetical condition that seems questionable, should always speak to someone from zoning and ask, “is this something that is feasible under certain protocols or processes?”.  Sometimes the answer is, “no” and therefore the hypothetical condition is more than a known false condition, its an outright lie that will never be the truth and under that condition the appraiser must say “no” to the assignment.  When the answer is “no, never” the requested condition cannot be met without misleading and that is unethical.  That is a condition you cannot accept.

This is Diana Jacob with ABC, “The Appraiser’s Business Companion” and you’ve just had a “tip of the week”.