Cost Approach and those who "mail it in"

[PropertyEconomics]

Fannie Mae states that the cost approach is to reflect the "depreciated value" of the subject property. Without including all forms of depreciation within the cost approach it would be my suggestion one is not following the Fannie Mae guideline ....

https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2008/0830.pdf

 

[Terrel L. Shields]

appraisers who use straight age life methods of depreciation, or straight line, will at some point (and probably many) not accurately reflect the true depreciation occuring in the market. It simply does not occur in a straight line and use of that method of depreciation, although allowable, is most probably not accurate. Is it accurate enough? Perhaps ... but it very well may not reflect the depreciation that is occuring in the market.

"Real" depreciation is reflected in individual houses...and that is one reason adjustments for "age" "condition" etc. are inprecise at best in the Sales approach. But if we use a book to calculate SF costs, then we can use their depreciation (residuals) charts in lieu of straight line or we can modify the depreciation to account for "short term"..(functional) and called it Modified age-life. Likewise, USPAP counsels us to be aware of and apply those methods, techniques, etc etc that our peers do and what the literature teaches. Applying our own standards or biases simply has its limits. And if you don't have at least one basic text covering basic principles...get one.

All of it is a "guess" of sorts...supported, but certainly not rigorous scientific proofs. I mean how many of us have appraised a property and claimed it has 20 years remaining life to only go back 5 years later and it is gone or abandoned?...or like the other thread about the $42 mil. "tear down"...

However, the difference between the Land value + Replacement Cost less physical depreciation should it differ from the sales price is a reflection of the obsolescences (as opposed to the deterioration). And that measurement when applied to the comps, should give you an understanding of where the actual CA MARKET VALUE is...and typically, if you have done it right, then the CA and SA should not be much different and that difference can be attributed to the precision of the measurements and the efficiency of the market..or lack of efficiency (volatility, risk, whatever)...

 

[J Grant]

Fair enough, PE, I look forward to the quote from the book and thank you! Too tired to engage more with the topic tonight, will return to it tommorow at some point,

 

[J Grant]

A "value indicator" that may not reflect "market value"?..??..

All the three approaches to value, CA, SCA, and icome, are value indicators and not market value indicators till an appraiser decides to rely on any of them as MV indicators, and states that in the reconcilliation.

Getting late and tired maybe someone else can address this too...a fundamental of appraising.

 

[J Grant]

JGrant .. question .. do you know how to calculate market derived depreciation from all forms?
__________________
Quick reply before I turn in for night...physical depreciation I use age/life method, functional if present I do paired sales on subject and comps without the functional obs, same for external obs such as backing a busy road, I market extract the amount from paired sales.

 

[PropertyEconomics]

JGrant .. question .. do you know how to calculate market derived depreciation from all forms?
__________________
Quick reply before I turn in for night...physical depreciation I use age/life method, functional if present I do paired sales on subject and comps without the functional obs, same for external obs such as backing a busy road, I market extract the amount from paired sales.

Well you know I disagree with age / life .. because one cannot determine the life of a home ... I bet you use effective age of the subject when you do this age / life method dont you?

Finally .. how do you measure external obsolescence related to the economy ....???

I am seeing you dont really have a handle on market derived depreciation, and that is ok, actually few residential appraisers do. I am certainly not putting you down for it ... but you argue very hard as if you know the theory and practice but I fear you dont.

But taking a cost approach class would do you great wonders and I strongly suggest and urge you to take one through the Appraisal Institute .. their education is head and shoulders above the rest in the market.

Good luck.

 

[PropertyEconomics]

"Real" depreciation is reflected in individual houses...and that is one reason adjustments for "age" "condition" etc. are inprecise at best in the Sales approach. But if we use a book to calculate SF costs, then we can use their depreciation (residuals) charts in lieu of straight line or we can modify the depreciation to account for "short term"..(functional) and called it Modified age-life. Likewise, USPAP counsels us to be aware of and apply those methods, techniques, etc etc that our peers do and what the literature teaches. Applying our own standards or biases simply has its limits. And if you don't have at least one basic text covering basic principles...get one.

All of it is a "guess" of sorts...supported, but certainly not rigorous scientific proofs. I mean how many of us have appraised a property and claimed it has 20 years remaining life to only go back 5 years later and it is gone or abandoned?...or like the other thread about the $42 mil. "tear down"...

However, the difference between the Land value + Replacement Cost less physical depreciation should it differ from the sales price is a reflection of the obsolescences (as opposed to the deterioration). And that measurement when applied to the comps, should give you an understanding of where the actual CA MARKET VALUE is...and typically, if you have done it right, then the CA and SA should not be much different and that difference can be attributed to the precision of the measurements and the efficiency of the market..or lack of efficiency (volatility, risk, whatever)...

Terrel .. I dont disagree with a thing you have written .. I am just very much not a fan of straight line depreciation because Im sure you would agree depreciation does not happen uniformly as a property or thing ages.
I prefer measurement from the market considering cost new, land values, contributory value of the improvements within a sale and actual ages ... It takes time but it does work.

 

[David Mescon]

And while I hate to disagree with Terrel ... appraisers who use straight age life methods of depreciation, or straight line, will at some point (and probably many) not accurately reflect the true depreciation occuring in the market. It simply does not occur in a straight line and use of that method of depreciation, although allowable, is most probably not accurate. Is it accurate enough? Perhaps ... but it very well may not reflect the depreciation that is occuring in the market.

Listening boys and girls? You guys just got a free nugget from the CA401 class. It generally looks like a parabola if you graph it out. Straight line is generally good enough, but it is also generally not all that indicative of real life.

 

[Michigan CG]

Appraising Residential Properties, Fourth Edition, page 82:

.....5. Estimate the amount of depreciation from an of the three major categories: physical deterioration, functional obsolescence, and external obsolescence.

6. Deduct the estimated depreciation from the total costs......

Page 268, same book:

......All three types of depreciation must be carefully estimated.....to arrive at the depreciated cost of the existing structure.

The Appraisal of Real Estate, Twelfth Edition, page 364:

.....The sum of all these components is total depreciation.....

 

[JSmith43]

continue doing it wrong you only harm yourself, your clients, and chance having the state review your work only to point out you simply dont understand the cost approach to value.

That was PE's quote. And here is a nugget of reality to back it up: We have a regular CG poster that lost his license in one state because he didn't overtly account for EI in the CA. Based upon that reaction, he might have done hard time for not including external depreciation in the current market:icon_mrgreen:

He remains active an another state that believes his work was reasonably competent and should not have been issued an economic death penalty. He was generous enough to share the details with the forum at one time. I don't reference his name, because lots of time has passed & I'm sure he doesn't want this issue & his name to hit first page Google searches forever. I'll PM it to you if you wish. He might not care & may even comment in the thread-the dispute was quite public.