Accurately Calculate Market Value (m = c - d + r)

[alebrewer]

which is why we use the "depreciated cost method" when performing the cost approach.

At least some of us perform the cost approach...

 

[Tom D]

when i was a r.e. broker oh so long ago. only speaking of row homes. when i kinda knew what the were looking for, i had to discover the hot button. i always remember them buying that house because they liked something about it. i have continually looked for the 'hot button' box on the market grid. never had a buyer who did much of what we do on an appraisal to determine what they were going to pay for it.. obviously they did see other homes, so there was some kind of comparison in their heads.

 

[Fernando]

When I look for commercial as investments, I look at the quality of the tenant.
Today the stock market went down and I noticed the retail stocks that did well in the pandemic went up today.
How do you factor that into your equation? It takes lot more to figure out this "short term" chaos in this Covid market today.

 

[glenn walker]

When I look for commercial as investments, I look at the quality of the tenant.
Today the stock market went down and I noticed the retail stocks that did well in the pandemic went up today.
How do you factor that into your equation? It takes lot more to figure out this "short term" chaos in this Covid market today.

Yes and going forward Covid-19 -20-21-22 will have a profound effcet on what will be considered Essential and Non-essential Real Estate . Look at Los Angeles County 10,000,000 people and as of Saturday the mandates are back in action - Restaurants already got killed and people don't like to eat indoors or outdoors with face masks on. This apply to vaccinated people to so its going to be another Bomb dropped on LA County businesses.

 

[Sadie]

ROI is not that difficult to determine if your willing to take the time to do the research. No different than determining the cost to build new or the amount of depreciation. It is just one more variable we must account for in order to be accurate and truly understand the adjustment. Also, the equation (m = c - d + r) can help you determine the ROI by solving for (r).

But is residential appraising, as Terrel L. Shields points out, ROI most likely doesn't come into play. One of the first things I was taught is that the residential real estate market is not logical. And it holds true.

 

[Sadie]

I disagree that "estimation of total cost by cost guides is a leap of faith at best". If you're not confident in performing the cost approach, then I beg you to take courses needed to become an expert. Also, the cost guide you choose to use is important as well. I have found the Marshall & Swift residential cost handbook to be very accurate. If you are using less credible (cheaper) resources for your cost data, then you may produce inaccurate results. In my opinion, the cost approach is more often relevant than not and should be performed in most appraisals. Thank you for your response.

However, as a residential appraiser you better get very comfortable with the Market Approach. If you are using a GSE form, the primary approach to value is the Market Approach. Read the boiler plate. And just wow if you the M & S is very accurate. Try some new construction appraising or just talk to builders that you know and trust.

 

[Fernando]

I don't know how commercial appraisers appraise now.
Areas which were once prime location have streets with many vacant stores and will stay vacant for long time until we get out of the COVID mess.
Short term, these properties are worth significantly less than before the pandemic.
How long this Covid situation last (unless most people get vaccinated) will undermine the accuracy of commercial values.

 

[RCA]

I disagree, but that's kind of the point of interaction, huh? Buyers typically don't factor in depreciation. Buyers typically determine whether some feature is functioning as it should, or if it's not, and if it is - what is the likelihood that it won't function in the near future. They don't calculate depreciation in order to arrive at a contributory value of the component. That's an appraiser paradigm...

Hope no beginning appraisers are putting any faith in what you are posting.

1. Of course buyers factor in depreciation, only they don't do an exact calculation. And depreciation is embedded in the sale price. The problem is extracting the depreciation in a reliable way, although quite frankly, you don't really need it as a separate value.

2. It's all a beauty contest. Really. Buyers line up all the alternatives and rank them according to their preferences along with the cost. Then they start off someplace in the list and move up and down by price and likeability until they find something with a combination of cost and appeal that they find satisfactory. They may factor in a discount with the seller they think they can bargain down. They may however fail.

3. And if so they continue to search and bargain, which may entail going back to the list again and even modifying it. They may or may not walk away with a purchase. And if they do buy something it may be used or new. Or maybe they can make their own from scratch.

The appraiser however, is in a position to analyze and quantify everything; the belief being that although the buyer is most likely unaware of what is really going on, it is underneath a mathematical process, which can be modeled through a very large selection of mathematical strategies and generalized models. There are very many available. Some are more useful in certain domains than others. For example Kriging works good in the oil industry for modeling subterranenan oil and shale deposits. And, that's because there is a certain continuity in and between different geological formations. Housing is different and more suitable for methods such as MARS. But there are many methods available. A ton of them in fact.

The beauty contest model is universal. Go to a beauty pageant and study the techniques - ... Not that I would, I would find it boring nowadays. But, then maybe 50 years ago when life was normal.

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[alebrewer]

Hope no beginning appraisers are putting any faith in what you are posting.

I hope no one anywhere puts any faith in what I post...

That said, I REALLY hope no appraiser (beginner, novice, or veteran) puts any faith in the proposition that appraising is like a beauty pageant...

 

[George Hatch]

I think the "beauty contest" analogy is as accurate an expression of cost/benefit comparisons as any.

Going back to the ROI, maybe it would be helpful to go back to the fundamentals. The premise of each approach to value is to that we are attempting to emulate the behavior of the market participants in these transactions. In the income approach it is the investor's position we are trying the emulate. In the cost approach it is the developer's position whether that developer intends to self-occupy the property or not. So the developers profit margin IS baked into the CA, and that margin IS distinct and separate from the contractor's margins.

Let's say you were an owner-user and you decided that your options for the existing home of your dreams sux. Your CA would consist of

Site acquisition
materials and labor
contractor's overhead in addition to the labor
fees, permits, bonds, etc
financing costs
contingency factor for the unknown costs which might pop up at random during the process
holding costs of the project during however long it takes to complete the project

and finally,
your potential savings (aka profit) coming from building your own instead of buying someone else's finished project. Because after all, you're not going to undertake the time/effort and risks of this project for free. You gots to be paid. We even call it the profit margin, or developer's profit or investor incentive or whatnot.

That potential savings (vs buying the existing unit) is your return on investment, whether you're an owner-user or a spec builder.

So going back to the CA in the GSE forms, they have aggregated ALL of the above factors (other than the site acquisition) into the "cost/sf". That "cost/sf" for the main structure includes the ROI for the entire project under the assumption that the other site improvements will be typical in scope and contribution.

That's why the base costs that go into that CA swing so widely, depending on where in the RE cycle the effective date is. During a bust there may be no margin for the developer; they sometimes end up losing. But during a bull run their potential margins might be in excess of 30%. The CA is a market approach and it does include consideration of the current market conditions whether we explicitly break that factor out or not.

As I've been saying, the development of the CA using the commercial cost guide actually uses different base costs because M&S doesn't aggregate the indirects and profit factors into their base costs in the commercial book - the appraisers tally those separately in those analyses based on what's applicable for that location and the current market conditions.

Long story short, the CA the GSE forms use is a simplified and abbreviated format which employs an aggregate "cost/sf" factor that assumes (at fixed/arbitrary rates) all those other elements in addition to the labor+material. The fixed/arbitrary nature of all those other assumptions is one of the main reasons the CAs which are performed in this manner sometimes don't turn out similarly to the results of the Sales Comparison. It's not that "the CA never works" so much as it is "the CAs which are performed using these fixed assumptions sometimes don't work".