Cost Approach and those who "mail it in"

[CANative]

An individual buyer would build for their own use to live in, and would not need EI to build. When did the cost approach to build morph into the cost approach to develop? (general question to all interested, not just to Mentor though am interested in his response as always!)

In development decisions (and this language may not be precise), there is only one property. The developer (or specualtor, sometimes) looks at the property "as is" and "as if" to determine if there appears to be sufficient EI to make a move. Also, these are property "investor" (not property user) decisions. That is, the "incentive" of anticipated "profit" drives the decision. Because it is an investor decision, that also drives the appraisal method. That's because the present value of the property is based on the as-completed value, less the cost to complete, less the incentive to complete. That incentive is the anticipated return on investment. Also, these are "transitional" properties because they are not at their current or ultimate HBU.

Good little rule of thumb to be extracted from the above - factoring incentive into a decision makes value lower, not higher. If the incentive is zero at $2, then it is 100% at $1. Little food for thought - doesn't that make incentive a form of depreciation in cost approach "theory?"

However, once you switch from decisions made by producers about whether to develop or not develop to decisions made by consumers, the basis of "incentive" either disappears or changes radically. You are leaving the world of transitional properties that are not at their ultimate or current HBU and need risk-takers to get them there, to patent properties that are at or near the HBU whose buyers love them just the way they are.

In this latter class of properties, you are know talking about people not making decisions about one property versus itself (as is versus as if), you are taking about decisions based on one property versus another. I don't see where incentive based on cost to construct enters the decision, because no one is going to be constructing anything. This includes any type of property where the buyer profile is someone who is unwilling or unable to build instead of buy, and this includes the vast majority of patent properties.

That leaves the segment of markets that is willing and able to build instead of buy patent properties. For SFR's these are usualy wealthy people and for commercial proerty this are usually large busness who want improvements to suit their use. They are not building to capture the incentive of value less cost in the short run, so incentive as a function of cost does not enter their decisions. Rather than go into what incentivizes these decisions, I think I'll put the ball back in someone else's court to explain why an existing home is worth $600k instead of $700k, because it would cost some wealthy couple $1 mil to custom build their "perfect" home.

 

[Mr Rex]

Yes, it answers all your questions.

 

[J Grant]

In development decisions (and this language may not be precise), there is only one property. The developer (or specualtor, sometimes) looks at the property "as is" and "as if" to determine if there appears to be sufficient EI to make a move. Also, these are property "investor" (not property user) decisions. That is, the "incentive" of anticipated "profit" drives the decision. Because it is an investor decision, that also drives the appraisal method. That's because the present value of the property is based on the as-completed value, less the cost to complete, less the incentive to complete. That incentive is the anticipated return on investment. Also, these are "transitional" properties because they are not at their current or ultimate HBU.

Good little rule of thumb to be extracted from the above - factoring incentive into a decision makes value lower, not higher. If the incentive is zero at $2, then it is 100% at $1. Little food for thought - doesn't that make incentive a form of depreciation in cost approach "theory?"

However, once you switch from decisions made by producers about whether to develop or not develop to decisions made by consumers, the basis of "incentive" either disappears or changes radically. You are leaving the world of transitional properties that are not at their ultimate or current HBU and need risk-takers to get them there, to patent properties that are at or near the HBU whose buyers love them just the way they are.

In this latter class of properties, you are know talking about people not making decisions about one property versus itself (as is versus as if), you are taking about decisions based on one property versus another. I don't see where incentive based on cost to construct enters the decision, because no one is going to be constructing anything. This includes any type of property where the buyer profile is someone who is unwilling or unable to build instead of buy, and this includes the vast majority of patent properties.

That leaves the segment of markets that is willing and able to build instead of buy patent properties. For SFR's these are usualy wealthy people and for commercial proerty this are usually large busness who want improvements to suit their use. They are not building to capture the incentive of value less cost in the short run, so incentive as a function of cost does not enter their decisions. Rather than go into what incentivizes these decisions, I think I'll put the ball back in someone else's court to explain why an existing home is worth $600k instead of $700k, because it would cost some wealthy couple $1 mil to custom build their "perfect" home.

A very good post and full of truisms...the problem with the CA is there are a bunch of truisms out there that all contradict each other...nobody builds without incentive to build...to a developer, the incentive is profit, to an owner occupant, the incentive is a brand new house built the way they want it on the lot of their choice.

The question remains... WHO is the cost approach addressing? IF we are doing a MV res appraisal for the typically motivated buyer of 130 Cherry Lane, (subject,) most of us assume typically motivated buyer is not a developer . In the CA section for 130 Cherry Lane, is the CA addressing what it would cost the typically motivated buyer (non developer) to BUILD, (their incentive is not profit, but a place to live), or the CA asking what it cost a developer to build 130 Cherry Lane (which would then add on developer profit, because they have no other reason to build, developers typically don't live in the houses they build, though they may indeed live in one out of the thousands they built)

Can somebody answer...is the CA supposed to address what it would cost a typically motivated buyer of subject to BUILD, either as a replacement or reproduction, the house at 130 Cherry Lane?

Or is the CA supposed to address what it would cost an entrepeneur to build and DEVELOP for profit the house 130 Cherry Lane? (130 Cherry Lane is subject)

 

[Mr Rex]

It would seem you have once again directed the discussion to the motivations of a "typical" buyer per the definition of market value. The irony.:new_smile-l:

 

[J Grant]

It would seem you have once again directed the discussion to the motivations of a "typical" buyer per the definition of market value. The irony.:new_smile-l:

Sorry, but it was people here pointing out that the CA is an approach to MV...thereore, since the MV purpose of a res appraisal is done for a buyer looking for owner occupancy, not a developer looking for profit, wouldn't the cost approach be addressed to the typical buyer of subject ( or typically motivated buyer , as stated in MV definition).

Since the typ motivated buyer of subject is not a developer (because then it would not be an owner occupied loan), then we are applying a cost approach what it would cost a non developer owner occupant what it would cost THEM to build, ( they would hire a contractor or small local builder), as they are looking to build as a replacement or reproduction of the subject to live in, not for profit.

So why are we then adding in EI/EP to the CA on a res appraisal, when the EI/EP is is what a developer would expect?

 

[Mr Rex]

Sorry, but it was people here pointing out that the CA is an approach to MV...thereore, since the MV purpose of a res appraisal is done for a buyer looking for owner occupancy, not a developer looking for profit, wouldn't the cost approach be addressed to the typical buyer of subject ( or typically motivated buyer , as stated in MV definition).

Since the typ motivated buyer of subject is not a developer (because then it would not be an owner occupied loan), then we are applying a cost approach what it would cost a non developer owner occupant what it would cost THEM to build, ( they would hire a contractor or small local builder), as they are looking to build as a replacement or reproduction of the subject to live in, not for profit.

So why are we then adding in EI/EP to the CA on a res appraisal, when the EI/EP is is what a developer would expect?

A developer does not typically buy houses.

 

[CANative]

If the developer sold the house to a buyer then he'd keep the profit between his cost and what he sold the house for. If the developer kept the house he developed then he wouldn't get the profit in the form of money. He'd get the profit in the form of not having to pay for the risks and delay payable to a different developer.

It's still in there.

 

[J Grant]

A developer does not typically buy houses.

Exactly my point. In a res appraisal, everything is MV around typ buyer, and all of a sudden in CA, we add in EI/EP which belongs to a developer, not a typ buyer.

(as you said, a developer is not a typ buyer, and it would be assumed typical buyer for our subject, if they chose to build a replacement or reproduction of subject, would be looking to live in it, just as they are looking to live in it now)

 

[CANative]

The cost is the cost and profit is an element of cost.

The buyer is not building a house. He's buying it from someone who took the risk and built a house.

If you don't put in EP you don't get MV... you just get the cost of the bricks and sticks. The SA is a direct method of developing a value. The CA is an indirect method.

 

[Mr Rex]

Exactly my point. In a res appraisal, everything is MV around typ buyer, and all of a sudden in CA, we add in EI/EP which belongs to a developer, not a typ buyer.

(as you said, a developer is not a typ buyer, and it would be assumed typical buyer for our subject, if they chose to build a replacement or reproduction of subject, would be looking to live in it, just as they are looking to live in it now)

You are intermixing buyers and sellers. Focus on one side or the other and you will have your answer.