Cost Approach and those who "mail it in"

[The Argus]

Many of the appraisal reports I have reviewed over the last few years have included the cost approach. In most cases the indicated value by cost approach ends up being within $5K or less of the indicated value provided through the Sales Comparison Approach. I have yet to see one of these reports where external (economic) depreciation was taken into account. In nearly every case where Marshall & Swift is cited as the source of cost data, it appears that local and regional multipliers were not used (or at best they were rounded).

IMO, if the cost approach is completed, and external (economic) depreciation is not taken into account, the number provided by the Cost Approach would be (in most cases) notably higher than the SCA.

Just about every builder (in my area) I have interviewed over this period of time has told me that they are essentially building in order to keep their crews working with breaking even as a goal, some even indicate that they operate at a slight loss. I have spoken to very few who are making a profit, and of those few, most indicate that the margins are slim. I spoke with someone at Marshall & Swift earlier this year, who informed me that the figures provided in their cost data take into account entrepeneurial profit.

Soooo...if the proivder of the cost data states that the figures include entrepeneurial profit, and most of the builders (not all) with whom I have spoken state that such profit does not exsist at this time, what is the relevance (or more importantly, the reliability) of the Cost Approach, when it matches (or nearly matches) the SCA, when economic depreciation is not included in the development of CA?

I am aware that many of the more experienced appraisers in my market (an presumably nationally) have been driven out of the business due to the changes caused by the HVCC. I am also aware that many of the people who came into the profession in the late 90s/early 2000s were not taught the proper way to develop the CA, many have told me that they were taught by their mentors during this period to "back in" to the number and to make sure that the figure was close to the SCA.

Are those of you who see the work of other Appraisers seeing what I am seeing? Seems that many are "mailing it in" when it comes to the CA.

Any (or at least most) thoughts are appreciated.

 

[hastalavista]

I spoke with someone at Marshall & Swift earlier this year, who informed me that the figures provided in their cost data take into account entrepeneurial profit.

This would be a significant change from the way they used to do it.

Are you sure they didn't say that they take into consideration "contractor profit & overhead"?

Two significantly different things (as I think you know based on your post).

 

[Mile High Trout]

There can be a separation there in terms of builder and lender and appraiser.

Regardless of the issue, these shortcomings in development and developmental guidance by clients seem to all have an origin in the lack of communication an appraiser can enjoy with the lender about scope, and lack of adherence to sound principals by the appraisal distributors or reviewers.

These approaches would confuse some users. Perhaps with a decent client and appraiser can communicate with, the appraisers approach towards this issue, may be considered in engagement and scope. It may be a problem to kick them all back for "light CA's", if the final opinion relies primarily on the market value approach.

There are so many CA arguments out there. I'm guessing there is something rooted in the checkbox review.

 

[CANative]

M&S does not (and logically cannot) included entrepreneurial profit, entrepreneurial incentive or economic obsolesence. Those are market factors.

And just because I'm such a nice guy here is a really good article to read. Terrel should read it twice. :icon_mrgreen:

http://www.federalappraisal.com/Pom...eneurial Profit and External Obsolescence.pdf

 

[Bill Streep]

Wow. You actually review appraisals where an attempt to use "real" numbers was made? About 19 out of 20 reviews I do have a "seat of the pants" (which is what I use in the review) attempt at the cost approach. "seat of the pants" = "out of your butt". In the rare event I actually see something that I can replicate with M & S, I complement it in the review.

 

[Michigan CG]

M&S does not (and logically cannot) included entrepreneurial profit, entrepreneurial incentive or economic obsolesence. Those are market factors.

That is correct.

 

[Lee Lansford]

This would be a significant change from the way they used to do it.

Are you sure they didn't say that they take into consideration "contractor profit & overhead"?

Two significantly different things (as I think you know based on your post).

You are correct.

No where in M&S' breakdown of costs does "EP" appear. You are correct re: "contractor profit & overhead".

 

[incognito]

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M&S does not (and logically cannot) included entrepreneurial profit, entrepreneurial incentive or economic obsolescence. Those are market factors.

BINGO.

I LOVE including the cost approach for those who require it (nearly always for insurance purposes). Rarely do I not include EO currently ( just like I rarely did not include EP and EI 5-7 years ago). It really throws the insurance agents for a loop when they see it and have no idea how to reconcile my cost approach with this "intangible" factor, into a usable insurable value for their purposes!

 

[Terrel L. Shields]

Terrel should read it twice

I have...and moreover, that article is a subject of discussion in a class I am developing...

I just completed an appraisal of 10 acres with a pole shop building on it.....I have 3 comps. All three comps are within a year or two the age of the subject - different sizes - one has a full concrete floor and a small office...but if you actually break out the contribution of those comps and vet the original RCN, using any reasonable straight line depreciation ... every comp fell short of the actual RCN less PHYSICAL depreciation. Thus an externality existed...and estimating that brought me face to face with the reality that those barns/shops suffered some 40% External Obsolescence. No real surprise, but I bet you won't find another appraiser on my side of the county that would go to the trouble of calculating that external obsolescence... They simply would add some 'stab' at value...which would have been easy to do. One of my comps was adjacent to another 5 acre parcel that sold for $10,000 less, so "paired sales" would suggest a "barn" [generic - forget size matters] is "worth" $10,000...that's about as sophisticated as my peers would get I bet.

So using the CA to "back into" a number in the comp is not only acceptable, but necessary to properly calculate the obsolescence imho...

I do agree most appraisers are incapable of using the CA. I see several reports lately where they used either $65 or $54 as the RCN on a brick home. It was the only way they could "make it work" I am sure when you have a 5 year old house...
10% depreciation of course...always. It's like the expense ratios.. 10%, 20%... never 14% or 31%...or vacancy rates.. 10%... 99% of all rental properties must suffer 10% vacancy. And the rentals? Always 10% renters, 90% homeowners... nevermind the national average is 38% renters. we kid ourselves a lot...

 

[Elliott]

If appraisers had the option of not including a CA, my guess would be that most
would say its not a particularly reliable approach and wouldn't include it. With land
value, EP, and depreciation, its pretty much a dog chasing its tail. I don't mail it
in, I find the land sales, set costs to local construction, and carry the depreciation
estimate from the MA. But I don't think its worth much more than spit in being
an indicator of value.