In recent years, the definitions for hypothetical conditions and extraordinary assumptions have changed as they pertain to appraisals.
In this blog, we’ll discuss what a hypothetical condition is and how it will impact those going through the appraisal process.
1. What is a hypothetical condition?
As recently as 2018, the definition for hypothetical condition has changed.
Previously, it was known as “that which is contrary to what exists but is supposed for the purpose of analysis.”
In other words, it assumes conditions contrary to known facts about physical, legal, or economic characteristics of a subject property (or about conditions external to the property).
This may relate to the market conditions or the trends regarding the integrity of data used in an analysis.
Today, a hypothetical condition is defined as “a condition, directly related to a specific assignment, which is contrary to what is known by the appraiser to exist on the effective date of the assignment results but is used for the purpose of analysis.”
In plain English, it is a condition the appraiser knows to be contrary to fact but takes to be true for reasons listed in the report.
2. When are hypothetical conditions used?
There are a couple of circumstances under which hypothetical conditions may be used.
Here are some examples.
Example 1: During an appraisal of a new dwelling with a current effective date, a hypothetical condition may be used to appraise the dwelling as if it were 100 percent complete on the effective date.
That said, the property would be known to be a vacant lot as of the appraisal’s effective date.
Example 2: A hypothetical condition may be used in the appraisal of a property that is subject to detrimental conditions (for example: environmental contamination).
In these circumstances, the property would be valued as if the detrimental condition doesn’t exist.
This may be done when the contamination is suspected but not proven.
Example 3: If a buyer is looking to request a rezoning or a zoning variance and wants to appraise the value as if it has a different zoning designation, a hypothetical condition could be used.
Say a single-family home is on a busy road and across the street from commercial properties: in this case, the property could be appraised as if it was zoned commercial if the rezoning was potentially feasible.
3. Why is it so important to disclose a hypothetical condition?
Disclosing hypothetical conditions is important because it ensures that everyone understands the state of the property and doesn’t over offer.
In example 1 above, a lender client could make a loan on the property believing that a large house exists.
However, the individuals who had the appraisal done would know that it is only a vacant lot.
For example, 2, a buyer might overpay for the property, believing the property is clean and livable.
Later, they would find out that there is environmental contamination, which would wreak havoc on their plans for the property.
4. What type of disclosure requirements exist?
The USPAP, Uniform Standard of Professional Appraisal Practices, has requirements for hypothetical conditions.
Their Standard Rule 2-2 requires that hypothetical conditions must be clearly and conspicuously stated.
Additionally, USPAP requires a statement that the use of the hypothetical condition might have affected the assignment results.
Although the USPAP does not provide guidelines for “clearly and conspicuously,” it’s important to follow the rule that the disclosure of a hypothetical condition should be made everywhere in the report where the value conclusion appears.
5. What should a disclosure statement look like?
For the building in Example 1, the following disclosure statement may be used:
The appraised value is based on the hypothetical condition that improvements have been completed as of the effective date of the appraisal, per the plans and specifications dated _________.
The use of this hypothetical condition might have affected the assignment results.
For the environmentally contaminated property in Example 2, the following disclosure statement may be used:
The property is subject to known environmental contamination; however, for the purposes of this appraisal, it is appraised as though it is uncontaminated.
This appraisal involves the use of a hypothetical condition, as the property is appraised contrary to what is known to exist as of the effective date of the appraisal.
The use of this hypothetical condition might have affected the assignment results.
6. What is an extraordinary assumption?
USPAP defines an extraordinary assumption as “an assignment-specific assumption as of the effective date regarding uncertain information used in the analysis, which if found to be false, could alter the appraiser’s opinion or conclusions.”
Unlike hypothetical conditions, extraordinary assumptions may or may not exist.
They’re often used in circumstances where the appraiser just isn’t sure about something due to lack of access.
Sometimes, extraordinary assumptions are used in situations like drive-by appraisals.
Such as when the property is inspected from the exterior (from the street).
Because they are not going inside the home, the appraiser will consult various sources to give the client the best information possible.
These resources include MLS listings, tax assessment records, Zillow, the homeowner, etc.
That said, regardless of how many other resources the appraiser has, nothing replaces an on-site inspection because those resources can contain an error.
Thus, appraisers often base their valuation on the extraordinary assumption that the information they receive is actually factual.
7. What’s the difference between hypothetical conditions and extraordinary assumptions?
The following example helps to illustrate the difference.
You’re doing an appraisal on an acreage property that was formerly used as a farm.
If you have no knowledge of contamination, an extraordinary assumption will apply.
Here’s how it would be written:
This appraisal was developed using the extraordinary assumption that the acreage being valued is assumed free of any environmental hazards, i.e., pesticides, herbicides, underground storage tanks, etc.
The appraiser is not aware of any environmental screening of the property as of the appraisal date.
The use of this extraordinary assumption might have affected the assignment results.
However, if the property has been tested, and you’re aware of property contamination, but you feel it is appropriate to value the property as “uncontaminated”, you would use a hypothetical condition.
Here’s how it would be written:
There is known contamination within the subject property.
With that, this appraisal has been developed using the hypothetical condition that the subject property is not contaminated or otherwise environmentally affected.
The use of this hypothetical condition might have affected the assignment results.
Final thoughts
Understanding what hypothetical condition is and where it’s relevant in an appraisal is critical when you’re looking to put in an offer on a property.
You should look for statements on hypothetical conditions and seek to understand how the property was evaluated by the appraiser.
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.