Cost Approach In New Construction

[George Hatch]

Our overarching ethos is to provide appraisal services that will be meaningful and not misleading to the intended users. Although the appraiser bears the responsibility for the decisions they make, they're still obliged to identify exactly what the intended users in an assignment will consider meaningful. One way to do that is to read the instructions for the assignment.

RTFM

When a client requests a Cost Approach that becomes one of the assignment conditions whether the appraiser thinks they need it to get to their opinion of market value or not. It's the same as when a client asks for an opinion of insurable value or a rent survey or an interior floorplan in their diagram or an FHA-style physical inspection. What the appraiser thinks about the reasonableness of those requests is almost irrelevant except to the extent they may actually be unable to find the info being requested.

It's not our job to tell our clients what is and isn't meaningful to them. It's not our job to tell them they can't have a Cost Approach if they think that information is meaningful to their decision. As a matter of fact, nobody really cares what the appraiser thinks of the meaningfulness of these other types of assignment conditions.

While the minimum benchmark for SOW decisions are dependent on the two-part test of our peers' actions and the expectations of other such users in similar assignments, that benchmark only refers to the MINIMUM amount of work that would be acceptable for that type of assignment. USPAP does not provide a ceiling to what an appraiser can accept in the way of assignment conditions - all USPAP does is tell appraisers its unethical to accept unreasonable (such as substandard) assignment conditions or to allow a client's preference to shortchange the minimums that would normally be required.

Asking what the value is by Cost is a perfectly legitimate question to ask, and having accepted an assignment that includes that expectation an appraiser would be remiss to arbitrarily decline to follow through after the fact. That many appraisers are technically incompetent to do a decent job at site valuation or to actually perform a decent cost approach doesn't make it an irrelevant approach to value, it only makes them incompetent at that type of analysis.

If someone thinks their 2-minute Cost approach returns a meaningless result the chances are quite high that they're right.

So yeah, I wouldn't hesitate to scorch that appraiser for unilaterally deciding to shortsheet their client and intended users. They made a deal when they accepted that assignment. if they didn't like the terms of that assignment the time to renegotiate it was before agreeing to it, not via power snivel "nobody else asks for this" after they've submitted the deficient workproduct.


Bust a deal, face the wheel.

 

[Terrel L. Shields]

When a client requests a Cost Approach that becomes one of the assignment conditions

Exactly...

And Std. 1-4 (b) details what is involved in the CA. Further, USPAP's first directive in Standard 1 (1-1) makes it very plain the appraiser must be "aware of, understand, and correctly employ those recognized methods and techniques that are necessary to produce a credible report"

Now, show me a general textbook (like "The Appraisal of Real Estate" which is truly the "bible" for appraisers) that does not state when and where the approach is APPLICABLE. Do not confuse APPLICABLE with NECESSARY. It might not be "necessary", but it is almost always APPLICABLE regardless age, condition, etc. In fact if you really study FHA and Fannie regs, they make it clear that the cost approach can be omitted but that does not give one a "bye" on the three types of depreciation. YOU MUST ADDRESS things like Functional and External Obsolescence whether you develop the CA or not. That is in their literature as well.

The textbooks make it clear. The CA is "especially persuasive when the site value is well supported and the improvements are new or suffer only minor accrued depreciation..." and "..can be applied to older properties when adequate data are available to measure accrued depreciation." And if you have three sales you almost always have enough data to support the accrued depreciation by using the CA in reverse and breaking out that total depreciation by market extraction.

4000.1

Depreciation from incurable external or functional obsolescence should be based on verifiable market
extractions, by paired sales analysis and capitalized rent loss
​

Fannie Mae Selling Guide

However, USPAP requires the appraiser to develop and report the result of any approach
to value that is necessary for credible assignment results. For example, when appraising proposed
or newly constructed properties, if the appraiser believes the cost approach is necessary for
credible assignment results, then the cost approach must be provided. ...This approach, then, measures
value as a cost of production. It may be appropriate to use the cost approach when appraising
new or proposed construction, property that is undergoing renovation, unique property, or
property that features functional depreciation, to support the sales comparison approach analysis.​

 

[BarrySW1963]

Sorry, do some reviews and run a Marshall and Swift using their parameters and you will see that what you get and what they get are many times VERY different.

How many appraisers do you think pay for the full Marshall and Swift book and the updates every year? How many appraisers do you think spend $10 PER REPORT to run a Marshall and Swift.

I personally know people who cite Marshall and Swift who have never even seen the book.

As to significant digits you are a little off. When one says they use the source then they report what the source says. One then rounds the results of the approach. The guys who actually use it report it as source reports it from my experience.

Eh, maybe. I pay for both the a la mode monthly swiftestimator ($75/month), and, when necessary, $11 per report for swiftestimator.com (highway robbery!!). I use the former for generic PUD-type Q4 to Q5 properties, and pop for the $11 when I need more granular cost for custom components (higher-end Q4 to Q3, not interested in most Q2 assignments). I also have a full set of the recent M&S books and DVD. It's like collecting cookbooks, the kind that delve into the real nitty gritty of the science. What gets used depends on what needs to be used to meet the requirements. Also, the M&S descriptions are lacking for which component in the book/tool is really the best match for something.

That being said, the results are only as good as what you feed the programs. All of the output is based on a combination of estimates and judgments (i.e. the quantity and quality of each component you define), and unless you have digital blueprints and the exact quantity of each component, the results just shouldn't be argued to be reliable to the penny. Even a bathroom vanity that is 6" wider than the underlying assumptions made for the selected quality level will change the results. Same for wider trim, solid core doors, etc.

I think we need to do a little experiment. Let's pick a house, and run the numbers. I'll bet we can get permission from an agent somewhere to use their photos of a recent/current listing, and then agree to some "facts" so everyone is working from the same baseline.

What do you think the spread will be?

 

[J Grant]

I assume after balking he completed the cost approach? If he did, then you are basically asking about the below:

I'd like to report the appraiser for this assignment to our state licensing because he was late on completing the assignment, increased his fee after accepting the assignment (he was given the information prior to accepting the assignment), and was very slow to respond to corrections (there were other issues in the report). While he ultimately addressed our concerns, it's taken 2 additional weeks for the review process because of his slow responses. Is this something that we can report?

You can report the above to a board but they'd almost certainly dismiss it. Nobody forces you to use certain appraisers, if he/she is slow, reluctant to do what is requested etc don't use them in the future? There are two sides to a story and we are only hearing your side. It would be interesting to hear the appraiser's version of events.

 

[George Hatch]

Eh, maybe. I pay for both the a la mode monthly swiftestimator ($75/month), and, when necessary, $11 per report for swiftestimator.com (highway robbery!!). I use the former for generic PUD-type Q4 to Q5 properties, and pop for the $11 when I need more granular cost for custom components (higher-end Q4 to Q3, not interested in most Q2 assignments). I also have a full set of the recent M&S books and DVD. It's like collecting cookbooks, the kind that delve into the real nitty gritty of the science. What gets used depends on what needs to be used to meet the requirements. Also, the M&S descriptions are lacking for which component in the book/tool is really the best match for something.

That being said, the results are only as good as what you feed the programs. All of the output is based on a combination of estimates and judgments (i.e. the quantity and quality of each component you define), and unless you have digital blueprints and the exact quantity of each component, the results just shouldn't be argued to be reliable to the penny. Even a bathroom vanity that is 6" wider than the underlying assumptions made for the selected quality level will change the results. Same for wider trim, solid core doors, etc.

I think we need to do a little experiment. Let's pick a house, and run the numbers. I'll bet we can get permission from an agent somewhere to use their photos of a recent/current listing, and then agree to some "facts" so everyone is working from the same baseline.

What do you think the spread will be?

First of all, no method of analysis can return a reasonable result unless the appraiser actually develops it. I don't call mindlessly plugging in cost numbers from thin air and backing into site value as the residual from the Sales Comparison analysis a reasonable expression of the Cost Approach. And inasmuch as that's exactly how an overwhelming majority of SFR appraisers do it I am not impressed by their opinion that their work in those analyses are not credible.

I think it's foolish to judge the validity of the Cost Approach based on what SFR appraisers do on that damn GSE form. That's an abbreviated format for cost analysis that uses aggregate figures that combine indirects, local multipliers and profit margins into the same price/sf. Outside of Fannie World, the appraisals that deploy the Cost Approach in all other appraisal disciplines break these different factors individually

Secondly, We don't do Sales Comparison Analyses or Income Approach to the penny, why would anyone expect a Cost Approach to be rounded to less than the nearest $5k?

It doesn't matter if some appraisers are incompetent at developing a particular mode of analysis. I've done a lot of appraisals involving construction and have seen a lot of construction cost breakdowns from the various contractors and in my experience it's *common* for my analyses to mesh with those breakdowns after consideration of what they do and don't include. Of course, over the years I've also sent more than one contractor back to the drawing board to work on their estimates. Which under some circumstances is precisely the point of asking for a Cost Approach.

In those assignments that have contractor cost breakdown info I show those costs as a parallel column to my costs for purposes of comparison.

Lastly, it still doesn't matter if the appraiser doesn't like the Cost Approach. The fact remains that if the assignment includes that or any other type of analysis due to client request and the appraiser accepted that assignment they are obliged to follow through. Which is the basis for the OPs complaint.

 

[bnmappraisal]

Lastly, it still doesn't matter if the appraiser doesn't like the Cost Approach. The fact remains that if the assignment includes that or any other type of analysis due to client request and the appraiser accepted that assignment they are obliged to follow through. Which is the basis for the OPs complaint.

Great post, George, and I love your last paragraph (my bold)

 

[BarrySW1963]

...Secondly, We don't do Sales Comparison Analyses or Income Approach to the penny, why would anyone expect a Cost Approach to be rounded to less than the nearest $5k?

That supports my point. Are you arguing against it?

 

[Tim Hicks (Texas)]

Eh, maybe. I pay for both the a la mode monthly swiftestimator ($75/month), and, when necessary, $11 per report for swiftestimator.com (highway robbery!!). I use the former for generic PUD-type Q4 to Q5 properties, and pop for the $11 when I need more granular cost for custom components (higher-end Q4 to Q3, not interested in most Q2 assignments). I also have a full set of the recent M&S books and DVD. It's like collecting cookbooks, the kind that delve into the real nitty gritty of the science. What gets used depends on what needs to be used to meet the requirements. Also, the M&S descriptions are lacking for which component in the book/tool is really the best match for something.

That being said, the results are only as good as what you feed the programs. All of the output is based on a combination of estimates and judgments (i.e. the quantity and quality of each component you define), and unless you have digital blueprints and the exact quantity of each component, the results just shouldn't be argued to be reliable to the penny. Even a bathroom vanity that is 6" wider than the underlying assumptions made for the selected quality level will change the results. Same for wider trim, solid core doors, etc.

I think we need to do a little experiment. Let's pick a house, and run the numbers. I'll bet we can get permission from an agent somewhere to use their photos of a recent/current listing, and then agree to some "facts" so everyone is working from the same baseline.

What do you think the spread will be?

Much like the entire appraisal process, the cost approach is not an exact science. However, the purpose to supply a credible cost approach. Pulling numbers out of the air and not using the actual Marshall & Swift is not a credible cost approach. If you have ever done Fannie Mae field reviews, you would know that the reviewer is asked if the cost approach can be replicated. It seems that 90% of the time it can not, because the numbers are just made up (backed in by the appraiser). If you actually use the Marshall & Swift Residential Cost Manual, you at least have a leg to stand on under review. That is the purpose of using some form of the M & S. So that you have a credible source. I have used it for 25 years and it has been very reliable. Every appraiser should learn to use the Marshall & Swift 1007 form. It is a great learning tool. I had to use this form on hundreds of manufactured home field reviews in the early 2000's. BTW, it was obvious that the cost approach on those appraisals were made up numbers.

Rationalizing that the cost approach is not reliable because it is not exact is really like saying the entire appraisal process is not reliable because it is not exact either.

 

[Tim Hicks (Texas)]

That supports my point. Are you arguing against it?

He didn't say the cost figures should be rounded, he implied the results. What cost figure have you ever used that was $5k per foot?

 

[BarrySW1963]

He didn't say the cost figures should be rounded, he implied the results. What cost figure have you ever used that was $5k per foot?

You mis-read his comment. He says, and I agree, that cost figures need to be rounded to a fairly large number (i.e., to the nearest $5k), because using more granular numbers suggests the approach is more accurate than it is.