Cost Approach and those who "mail it in"

[Meandering]

Ken,

Actually I was only referring to Residential, not commercial. In commercial, sometime the CA is all you have and is actually the most reliable indicator of value.

I was referring to the CG that stated the Cost Approach is meaningless.

In residential, sometimes, the cost approach is all you have and is the most reliable indicator of value. Here, a local attorney constructed and lives in a full brownstone replica of the Connecticut governor’s mansion. There are no comps, and nothing that will ever be a comp as it is in the midst of a farming community. So with this super-adequacy, we must look to the Cost Approach as there are no resale substitutes and no buyer would equally consider it among other improved properties in the area. Ditto that for one 10,000 square foot home with it's own private airstrip. There maybe similar buildings in another state, but that does not make them comps, therefore the Cost Approach is the most relevant approach.

I do not buy the argument that the CA would have saved the market when prices were increasing dramatically.

I agree, builders raised their prices in-line with price increases in resales. But for similar properties with similar homes, new ones should represent a price ceiling without any consideration for depreciation. However, when you get into areas with building moratoriums, this may not hold true because resales have no new construction to compete with, then it must be determined if the location of that neighborhood is enough to entice buyers to pay more or to build new in a different neighborhood.

All of this is more than just form filing. Since it is considered acceptable practice to back into the land value, all of that depreciation would have been attributed to land value.

Not in my neck of the woods.
 

You are correct in saying that old houses should not have been selling for more than new houses. That is a problem with the Sales Comparison Approach and the Principle of Substitution should have been applied.

This is only good when builders utilize the MLS. When builders are advertising in newspapers and magazines, many appraisers act as those they don’t exist or participate in the market. It takes time and research to check with area builders to see what they’re doing and have done. This is something that the AMCs and less better trained don’t allow time for, or think is beyond the scope of their work.

I still have not seen an appraiser here that supports the CA as a viable approach in residential appraisals ALSO state that they spend 1 to 1.5 hours doing one for each appraisal. My point being that if you are not spending over 1 hour on the CA, you are not doing a CA, you are doing some sort of form filling copied from some cost handbook.

I once spent an entire day on a cost approach and then gave it no weight in the final analysis because it was built where it should not have been, the land, if vacant on that day was an unbuildable lot due to high water tables, wetlands and zoning, so establishing a land value with supporting documentation and commentary took the whole day to track and verify other similar land sales, to say the whole thing was an intellectual exercise, but was a part of my scope of the work and had relevance to my client, but not to my market value as I had resales of other homes on similar land.

I know that many spend much time and effort in here trying to support all of the different types of obsolecence in the CA, plus the land value (All obtained from sales, not costs), but it comes back to the old "Garbage in - Garbage out" saying. How can you state that your CA is reliable when the very basis for most of your CA is flawed and based on some cost handbook and not on actual costs? (Garbage In) And then to make things murkier, you apply the Sales Comparison approach to determine depreciation and Obsolescence and land value? So you have a flawed cost new, and a completely different approach used to apply large "Adjustments" to the CA. (Garbage Out)

I don't disagree with you here, but it's pretty much the same for any approach, GIGO, garbage in, garbage out. If the work is not competently researched and analyzed, the whole exercise is worthless to everyone. So to that I will include that land values can not easily be established in some areas, so this takes even more research and analysis. But as I’ve said in this post already, we have purchases where some of the buildings where razed and new buildings constructed, that makes those sales, land sales, even though they don’t show up in the MLS land sale section of the software. And, all the costs to remediate the existing structure back to usable land, are still applicable in the Cost Approach as they are part of the costs of getting to a site that is vacant and ready for development.

All of this comes down to knowing the neighborhoods, or at the very least, driving the neighborhood. In neighborhoods of 1950 ranch homes that are fully developed, the one or two 2,000 SF new colonials should be an indicator that some one bulldozed the home that was there for whatever reason, to build the home that is there now. But then again, it goes toward the amount of work some people put into their reports.

I used to be in the position of thinking that the CA was effective. I used to argue and laugh at those that tried to tell me it was useless. It was not until I got a job doing the CA that I came to realize how useless, flawed and unreliable the CA that residental appraisers use on the 1004.

I’m not sure I’m reading this right. Are you saying that until you had to do a cost approach it was a good thing, but then after you did it was flawed?

There are many times when the cost approach does not represent a viable alternative for a prospective buyer of an existing home. But that does not make the Cost Approach flawed. As I’m sure many take the position, especially now, that when the Cost Approach indicates a cost new of $200,000 for a 6 year old home and you have multiple resales in the $80,000 to $140,000 range and cannot attribute the number difference between the Cost Approach and the Sales Comparison Approach as all being physical depreciation, that many think the Cost Approach is flawed. But that just is not the case. The Cost Approach must be cross referenced with the local builders, and if the builders and Marshall and Swift agree, the issue then is two fold. 1. what are the local builders doing? If they are not building or moved out of town, the Cost Approach is the answer why, or if they are building and selling far above resales, you need to reconcile your typical buyer in the neighborhood. And, 2. If they are not building or selling, then you have a market condition that is not typical and needs to be addressed in the Cost Approach in more detail.

No one here has stated any argument for the CA that I have not used or seen before, and all of the arguments for the CA are flawed. This is because it is not typically used properly, and when it actuall is used properly (I have never seen it done properly), it is only accurate for replacement cost new. If you want to later apply land values, depreciation (Very flawed) or obsolescense, then stop calling it a CA and name it as a Sales Comparison Approach/CA hybrid.

I’m not a fan of applying depreciation in the Cost Approach. The difference between the Cost new and the resale market is the market recognized depreciation in my mind, once you are talking about 10 years old or older homes. And when you’re talking about 100 year old homes, its just silly, so I’ll give you all of that. But the Cost Approach indicates nuances in the market conditions that may not be expressed in the universe of 1 year sales in a neighborhood, in the MLS, and for that reason it is important for support of market condition analysis, which is something else many don’t do correctly if the MLS does not spit it out for them.


.

 

[J Grant]

Yeah that JR character turned out to be a tool...frequent posters here for the most part are passionate about appraisal and want to share their knowledge. For me, even when I am busy, it is a great break to interact with peers...pears...peeps...

Anyway, overall I agree with Ken's assesment of CA in most residential at least. I was referred to the published texts and used EC obs on my last few reports and it is easy to do and lines up the value more closely with the SCA . And I have no problem doing it. But in reality, and it is the fault of whoever designed the CA, it is a very flawed approach and is a hybrid of market approach using the same conclusions the appraiser came to in the report to either back into the approach with EI /EP or back out of it with the same ec obs derived from the report itself. As Ken said, garbage in, garbage out, unless the appraiser is very astute and aware of the sales and what the market is really doing, esp in unstable markets.

An example from the supposed better use of CA, new construction/recently built homes 1-2 years old. An appraiser goes in a development, does a report on a new construction home, uses all builder comps and one outside high price sale and gets a value of 400k that just happens to match the sale price of builder new home. Appraiser adds in more and more EI and adds more to land value till the CA value is very close to the SCA value of 400k.

Meanwhile, on the same day, down the street, a six month old model match to subject on same lot type is on the resale market, and has a 350k sale contract price (all the resales are lower, because the builder sales were inflated prices). So now the same appraiser appraises the model match, with minimal depreciation, drags in a few resales (which he should have used in the first report), and now the SCA value is 350k to match sales price ...or maybe appraiser brings it in at 360k , the highest model match resale.

Appraiser deducts the SCA value from cost new and applies it as economic obs. On the very same day, in the same development, the appraiser gave the builder model 40k in EI and the resale 40k in ec obs.

So which is the market doing? Going up or down? Is there really that much economic obs in the market? Then why when wasn't the ec ext obs applied to the builder new home? Oh, because if "done correctly," the approaches are supposed to yield close values to each other. Done corectly...it means that the same ec or EI derived from appraiser's own report is added or subtracted till the values match. The huge flaw in this, is that if the appraiser was trying to make a value, and used the wrong comps, or was market ignorant and used the wrong comps, the EI or ec ext is wrong too, but it is used to make the CA look right...or at least line up with a possibly flawed SCA value.

Back in the new development...on the same day, this appraiser makes the ec obs disappear in the new home, and drags it back in on the resale home. This is the flaw in the CA...the ec obs or EI has less to do with the market and more to do with possible flawed SCA value and is extracted from the same value on report to make the values line up, and then explained as extracted from "the market"... a circular loop that proves itself right...(but may not be credible if the proper comps or analyses is used to arrive at a more accurate SCA value)

A fact based CA, free of subjective applications of EI and ec obs, would provide a better measure of at least cost to build, and land to value ratio, and show the imbalance in a market where prices are rapidly rising or declining, or where resale recently built homes are selling at diff price points than brand new model match builder homes in same development.

 

[Michigan CG]

.....I do not buy the argument that the CA would have saved the market when prices were increasing dramatically.......

There are a lot of IFS...IF cost approaches were done correctly back in the day they would have shown significant EI/EP.

Then IF smart people were actually looking at them at Fannie/Freddie they would have seen that the EI/EP was getting way out of hand.

Then IF someone reacted.......but I digress.

.................................

......all of that depreciation would have been attributed to land value......

I have done three cost approaches for new construction in the last 10 days. The EO is not all in the land. Take a typical 2 acre rural lot that was selling for $50,000 four years ago. It is now selling for $20,000. There is still more EO in the construction and the land sales already show the decreases in value. And those cost approaches took me about an hour to do.

 

[J Grant]

IF cost approaches were done correctly back in the day they would have shown significant EI/EP.

The problem is, EI/EP is not a sep line item, and is blended into the cost to build on top of contractor profit, so how would an appraisal user/client even know what the amount of EP/EI was? And when the EP?EI was so "signficant" that the market could not support it, appraisers were supposed to comment, and perhaps not include amounts market could not support.

Then IF smart people were actually looking at them at Fannie/Freddie they would have seen that the EI/EP was getting way out of hand.

If an appraiser saw the EP/EI was getting "out of hand", they should have stoppped adding it to the CA. I stopped adding it when it got out of hand. Translation, for out of hand....when the EI /EP is above what the market could support IF the right comps are used, not comps to make a high value are used.

Then IF someone reacted.......but I digress

Well, yeah, how could they react when it was hidden and they couldn't see it, and an appraiser gave no comment if the EI /EP was supportable by resales in a new home subdivision, for example?

 

[J Grant]

In residential, sometimes, the cost approach is all you have and is the most reliable indicator of value.

It can be a reliable indicator of value, but in a case with no comps, how do you know it is a reliable indicator of MV? If there are no comps, chances are the building or home is an overimprovement, or super adequacy...so is that addressed elsewhere in the report, or is the CA value just left as is? I don't care if a lender wants to lend on a CA value alone, but it may not be MV.

Here, a local attorney constructed and lives in a full brownstone replica of the Connecticut governor’s mansion. There are no comps, and nothing that will ever be a comp as it is in the midst of a farming community.

Figures an attorney has the ego to replicate a gov mansion in the middle of a farming community. So you develop the CA and it shows X, who in that area would ever buy that elephant of a house ? The fact that there are no comps imo shows a big adjustment for over improvement or super adq, so how reliable is CA as a MV?

So with this super-adequacy, we must look to the Cost Approach as there are no resale substitutes and no buyer would equally consider it among other improved properties in the area.

Right, so how is the super adequacy addressed in the report? It cost a million to build, but there are no buyers for it and the most someone would pay might be 400k, based on the highest sales of bigger, new homes in area.

Ditto that for one 10,000 square foot home with it's own private airstrip. There maybe similar buildings in another state, but that does not make them comps, therefore the Cost Approach is the most relevant approach

Right, there are no private airstrip homes in area, like one buyer out a 100,000 would want that...so is the CA MV? Any listings of similar that sat on the market 3 years and then were expired? There are ways to find out worth or lack of worth, or at least marketing time. A priv airstrip oddball house in another state might at least tell an appraiser that.

 

[Michigan CG]

IF cost approaches were done correctly back in the day they would have shown significant EI/EP.

The problem is, EI/EP is not a sep line item, and is blended into the cost to build on top of contractor profit, so how would an appraiser user or client even know what the amount of EP/EI was? And when the EP?EI was so "signficant" the market could not support it, appraisers were supposed to comment, not just add endless amounts in.

Then IF smart people were actually looking at them at Fannie/Freddie they would have seen that the EI/EP was getting way out of hand.

If an appraiser saw the EP/EI was getting "out of hand", they should have stoppped adding it to the CA. I stopped adding it when it got out of hand. Translation, for out of hand....when the EI /EP is above what the market could support IF the right comps are used, not comps to make a high value are used.

Then IF someone reacted.......but I digress

Well, yeah, how could they react when it was hidden and they couldn't see it, and an appraiser gave no comment if the EI /EP was supportable by resales in a new home subdivision, for example?

m2:

I swear I am going to call you one of these days and explain this whole thing to you.

 

[hastalavista]

The problem is, EI/EP is not a sep line item, and is blended into the cost to build on top of contractor profit, so how would an appraiser user or client even know what the amount of EP/EI was? And when the EP?EI was so "signficant" the market could not support it, appraisers were supposed to comment, not just add endless amounts in.

(my bold)

Your comment above argues that the form's pre-printed criteria must (or should) direct all of the development and reporting process. That is an error IMHO.

I'm sure you make separate adjustments in the SCA grid for items that are not part of the pre-printed selection if such adjustments are appropriate for credible results (SR1).
If you do not, but lump them into a pre-printed line, I'm sure you explain what has been added and why (necessary for meeting the reporting requirements- SR2).

If you do neither of the two above, then it sounds to me like you are allowing the form to direct your development and reporting process; that works if the form's content is sufficient enough for the appraiser to develop and report credible results.
Many times I have to add additional items in each of the form's pre-printed valuation-approach sections and explain what they are so that the reader can properly understand how I developed my results.

The argument that the form neither requires or provides a 'line' for proper development and reporting of the valuation process is not a sound argument at all.
:new_smile-l:

 

[Pittsburgh Pete]

The form made me do it!

 

[CANative]

m2:

I swear I am going to call you one of these days and explain this whole thing to you.

Why?

This thread is sad and funny. It's also frustrating because I don't have the time to post really long explanations. I'm chomping at the bit to discuss why real cost approaches might have slowed things down; why including EI as a separate line item is a more technically correct method; why EO can be present in just the land, just the improvements or in both the land and improvements; etc., etc.

 

[Elliott]

Michigan said, "I swear I am going to call you one of these days and explain this whole thing to you."

CANative said, "Why?"

Appraising is an art. We all think we learned how to do something early in our career
because of a class or a mentor. Some admonitions rattle around in our heads more than others.