Cost Approach and those who "mail it in"

[J Grant]

"The cost approach reflects market thinking because market participants relate value to cost. Buyers tend to judge the value of an existing structure not only by considering the prices and rents of similar buildings, but also by comparing the cost to create a new building with optimal physical condition and functional utility.

This sounds good in theory but in reality is not the way most buyers think There is a big difference between a buyer for a new and used home or condo, and they seldom cross lines (though they can). To complicate matters is location....most older homes are located closer to urban centers or are located downtwon, or near the beach or river etc.

Due to perferred location, many will buy an older home a short drive to the city than a newer home further out. When there is spot new construction in an older prime location area, the cost is usually beyond the typical older home buyer's reach. Most new home developments are further out from urban centers though the new home sprawl creates new towns centers. Some buyers perfer old historic charm and won't buy new. Others, typically growing families will buy the bigger new home further way.

The complexity and fixed location of RE is why new vs old is so different than in comparing it to new vs old cars or cost of a can of peas.

Moreover, buyers adjust the prices they are will to pay by estimating the costs to bring an existing structure up to the physical condition and functional utility they desire."

The Appraisal of Real Estate, 13th Edition.

This has more truth in real buyer behaviour..no matter where or what they purchase, most buyers would perfer an updated kitchen, newer roof etc, and the more depreciated the house, the less they will pay (unless it is very unique or has historic value)

 

[Joyce Potts]

I had this discussion with another SRA just the other day and was amazed when he told me that he just lets his reports go out with the Cost Approach signficantly higher than the Sales Comparison Approach. I never have agreed with that.

1 - I don't use Marshall and Swift but use local builder data and input.

2 - I never back onto a Cost Approach because even though I caveat my report that it should not be relied on for insurance purpose, on the outside chance they do, I'd rather err on the side of caution and go slightly her on the replacement cost.

3 - No one that I know of EVER SAID the Cost Approach was a complete, INDEPENDENT approach to value. It is not. All forms of depreciation ARE MARKET DERIVED, so how could it be?

With that said, don't dismiss it as useless, because it's not if you truly understand it. (Do a FULL Demo). The difference between the cost to replace and what the current open marketplace is paying is external obsolesecnce, plain and simple.

AT LEAST IN MY DEPLORABLE CENTRAL FLORIDA MARKET.

 

[J Grant]

I had this discussion with another SRA just the other day and was amazed when he told me that he just lets his reports go out with the Cost Approach signficantly higher than the Sales Comparison Approach. I never have agreed with that.

That is what I was doing till today... Good to know an SRA has same theory.

1 - I don't use Marshall and Swift but use local builder data and input.

2 - I never back onto a Cost Approach because even though I caveat my report that it should not be relied on for insurance purpose, on the outside chance they do, I'd rather err on the side of caution and go slightly her on the replacement cost.

Good methodlogy

3 - No one that I know of EVER SAID the Cost Approach was a complete, INDEPENDENT approach to value. It is not. All forms of depreciation ARE MARKET DERIVED, so how could it be?

All the data we rely on is market derived (where else would we get it from?) but that still does not mean the result of any of the approaches is market value ( the appraiser decides which of the approaches to value results in a credible support for an opinion if market value, that's why we make the big bucks, aka, this where our responsiblity lies, when we make the judgement call, which of the 3 approaches to value have led to a credible basis for supporting our opinion of MV.

The appraiser states which ,(or all) of the approaches to value they are relying on and how strongly they are weighted in the reconciliation, and THEN the appraiser arrives at their opinon of MV.

Preceding the reconciliation, the approaches to value are developed indepedently of each other, though each of course uses market derived data, so in that sense there is a connection.

With that said don't dismiss it as useless, because it's not if you truly understand it. (Do a FULL Demo). The difference between the cost to replace and what the current open marketplace is paying is external obsolesecnce, plain and simple.

I agree with this statement. The question is, whether a clearer picture is given to users of appraisal by including the ext obs back into the CA, or leaving it out, as the SRA you noted did ( and I tend to do, till I was advised on this board not to...??)

AT LEAST IN MY DEPLORABLE CENTRAL FLORIDA MARKET.

My market is deplorable too ...

 

[JSmith43]

Nice post, Joyce.

 

[incognito]

NONE of the value indicators are MV indicators until an appraiser decides they are reliable as such

I'm not sure I should even waste my time. It is ludicrous to suggest that an approach to value is not an indicator of market value UNTIL the appraiser decides it is a reliable indicator of value. It may not be a "credible" indicator of market value, but it IS an indicator of market value. I could go on and on, but I sense I would be wasting my time...

 

[NC Appraising]

FWIW,

Every appraiser in my market, and probably in the USA should be turned in to the board, including me, because what we say is "average" quality for tract built homes is really "fair" in Marshal and Swift. That is one of the reasons for the "high" cost approach.

Square sided vinyl home on a slab foudation...... fair!!! Have we ever seen a fair rated home in any appraisal? That is about as rare as appraisers marking the "increasing" box during 2006-2007. I guess they were wrong?


How about those high-end homes



How do you handle upgrades and other features?

 

[PropertyEconomics]

JGrant ... as I promised I would do .... the following are passages for you to ponder:

Appraising Residential Properties – Fourth Edition – Appraisal Institute - 2007
CHAPTER 13 – The Cost Approach
Page 256, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“To apply the cost approach an appraiser estimates the cost of reproducing or replacing the existing structure with a new building, deducts an appropriate amount of the loss in value caused by depreciation in the existing structure, and then adds the value of the depreciated improvements to an estimate of value of the land.”

Page 256, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“An appraiser …. Estimates the amount of depreciation in the structure, and if necessary, allocates it among the three major categories: physical deterioration, functional obsolescence, and external obsolescence.”

Page 260, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“Not only can the cost approach be used as an independent approach to market value, but information derived in the approach can also be applied in other valuation approaches.”

Page 267, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“The depreciation estimate is a critical element in the cost approach and is often quite difficult to develop.” … “Depreciation is the amount by which the replacement or reproduction cost of a new structure must be adjusted to reflect the value of the existing structure. There are three main types of depreciation: 1) Physical deterioration; 2) Functional obsolescence; 3) External obsolescence.

Page 268, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“All three types of depreciation must be carefully estimated, added together, and deducted from the cost new of the improvements to arrive at the depreciated cost of the existing structure.”

Page 269, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“Normally the last step in the cost approach is accomplished by adding the depreciated costs of the improvements to the value of the site. The depreciated costs of all the structures on the property are combined to obtain the value contribution of the improvements. This sum is then added to the land or site value estimate to obtain a total property value indication by the cost approach. This value indication will be the value of the fee simple interest in the subject property. If the property rights being valued reflect a different ownership interest, the indicated fee simple value must be adjusted to reflect the interest being appraised.”

CHAPTER 15 - Depreciation
Page 283, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“Depreciation is the difference between the reproduction or replacement cost of an improvement and its market value as of the date of the appraisal.”
“This model accounts for all elements of the total depreciation estimate. If a particular element is not a form of physical deterioration, it must be some form of obsolescence; elements of total depreciation that do not qualify as physical deterioration or functional obsolescence must be a form of external obsolescence.

Page 291, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“Regardless of the method applied, an appraiser must ensure that the final estimate of depreciation reflects the loss in value from all causes …”
“An appraiser must estimate depreciation using the same basis from which costs are calculated – either reproduction or replacement cost.”

Page 292, Appraising Residential Properties, Fourth Edition, Appraisal Institute
“Any feature that creates a loss in value from the cost standard must be accounted for as an item of depreciation.”

The Dictionary of Real Estate Appraisal – Fourth Edition – Appraisal Institute – 2002

Page 79-80
“Depreciation –
1. In appraising, a loss in property value from any cause; the difference between the cost of an improvement on the effective date of the appraisal and the market value of the improvement on the same date.”


JGrant .. if both of these publications are not in your appraisal library .. I urge you to obtain them. They are tremendous resources and provide definitions and methodologies that will be useful in your everyday work ... again I urge you to obtain them if you dont have them.

 

[Elliott]

NC said "Every appraiser in my market, and probably in the USA should be turned in to the board, including me, because what we say is "average" quality for tract built homes is really "fair" in Marshal and Swift. That is one of the reasons for the "high" cost approach. "

Correct me if I'm wrong, but didn't USPAP 2004 (+ or - a USPAP) establish local peer standards? I remember getting an email suggesting us local appraisers should get together for coffee. I thought we all sync-ed up to establish local standards and our periods.

 

[Michigan CG]

Appraising Residential Properties – Fourth Edition – Appraisal Institute - 2007

The Dictionary of Real Estate Appraisal – Fourth Edition – Appraisal Institute – 2002...... if both of these publications are not in your appraisal library .. I urge you to obtain them. They are tremendous resources and provide definitions and methodologies that will be useful in your everyday work ... again I urge you to obtain them if you dont have them.

You are being too nice. Any appraiser who does residential work who does not have these publications or similar publications does not take the profession seriously.

How does one proclaim to be a professional and not have the premier resources at their disposal for daily work?

 

[PropertyEconomics]

You are being too nice. Any appraiser who does residential work who does not have these publications or similar publications does not take the profession seriously.

How does one proclaim to be a professional and not have the premier resources at their disposal for daily work?

Actually Michigan .. I hear there is a new FIFTH EDITION of the Dictionary out but I have not sprung its purchase yet ... Im sure I will though.

Besides .. I was feeling kinder and gentler this evening ... my un-nice will show up in the future Im sure ..... :laugh: