Cost Approach Lower than Sales Approach

[Elliott]

Grace,
The UW is an idiot and pulling this out of his butt.

I will believe the CA has validity when:

-Buyers of property produce a builder's
cost bid before they buy an existing house.
And that bid better match M&S.

-Sellers of a house produce a builder's cost
bid before they sell a house.

elliott

 

[Bobby Bucks]

6%....this one should separate the slovenly, reasonable appraisers from the rocket scientist wing.

 

[DTB]

Don't worry someone will be along shortly to show you the " correct" way of making it work.

 

[Pamela Crowley (Florida)]

The cost approach doesn't have a whole lot to do with the Definition of Market Value on the Fannie forms anyway.

Added:

The UW is having trouble with the insurance, not the appraisal.

 

[Willie]

Will,

I just got back from inspecting a manufactured house for a purchase transaction. $175k. Although there are only a few sales in this isolated community in any year, there are enough to show that $175k is not unreasonable.

But, there are tons of recent sales of lots. Some sales only a few weeks old. I just did an appraisal of an almost idential lot just 3 weeks ago. The land value is $60k. Doing a quick CA in my head while I was driving back it adds up to:

$60k for the lot
$30k for the depreciated 1988 Sandalwood MH
$10k for the garage
$20k for foundation, hookups, drive, grading, setting, permit, fees and taxes etc.
$7.5k for decking, minimal landscape, and flatwork
$12k +- for marketing & misc.

$139,500.

Even if you figure 15-20% EP or developer profit for the new MH's in this community, that only adds up to $160,000 - $166,000 max.

Now what?

Greg, first I will answer your question, as best I can. Second and much more important, I will give you some advice, as I have done in the past, and I hope you will remember, even having taken the advice.

The answer to your question, is that you are operating in a very inefficient market. The following assumes all your numbers are accurate and or maxed out in terms of reasonableness, ie garage at $10,000. What you have are: uninformed buyers of manufactured home properties, who don't know their depreciated worth. I would be uninformed if I weren't in the market every day, and maybe am anyway, uninformed sellers of their land, who are selling it to low, and excessive entreprenurial profits and possibly, but doubtful, your over estimation of the comparables condition/depreciation they have suffered. It could be one or, as I suspect, it likely is a combination all of these, but especially the under selling of the lots and over estimation of the MH's value.

Now to my advice. Greg, what you have is a very inefficient market, which is moving upward. You have to remember, that all of the highly profitable opportunities in real estate are because of this inefficiency. What you are saying, Greg, is that you can build this for $127,500($139,500 -$12000) and sell it for $175,000. What this means is that you could make a profit for yourself of $175,000 x .94(real estate commissionat 6%) -$127, 500 or roughly $37,000, which is closer to a 25+% EP, and maybe the real number, assuming all your other factors you have estimated are dead on..

You don't give the marketing time, but if it's say 3 months, you could do 4 of these a year, and make $148,000 per year, probably in your spare time.

Beats the heck out of appraising and much more profitable on an hourly basis.

 

[Willie]

Naw, the builders would contract to build for less than the speculators have been selling the new contruction never been lived in ones they contracted for 6+ months ago. The Costs Approach for new as of the effective date of the appraisals really was lower than the Sales.

Pamela, I'll read this again, but my first read is that this does not make sense. Builders in a given subdivision? In competing subdivisions?

 

[DTB]

Be prepared to duck.

I usually get the dope slap for bringing up ways to make money using our knowledge in ways other than appraising.

 

[Bobby Bucks]

You have to remember, that all of the highly profitable opportunities in real estate are because of this inefficiency.

I can't disagree with that. I suppose there are two ways to look at it.
(1) It's an inperfect,vile, unfair system.
or
(2) It's the land of milk & honey.


.

 

[Pamela Crowley (Florida)]

If one was willing to wait for the house to be built, they could get it for less than what the new speculator owned, vacant, and for sale properties had been going for.

 

[JSmith43]

The real answer is: Underwriters are used to appraisers backing into an indicated value by the cost approach since the beginning of time?....well, since the breath of life was applied that gave life to the cost approach.

Of course, when appraisers are free to back into something, why not back in a bit high (observed)? Whatever the reason, underwriters are used to seeing the cost approach coming in high. I'd blame it on the books and anyone and everyone that repeated over the years this little gem: "The cost approach tends to set the upper limit of value."

That should be an invalid statement, or at least unprovable theoretically, since the estimate of reproduction/replacement is just as likely to be low as high, the estimate of land value is just as likely to be low as high and the estimate of depreciation is just as likely to be low as high, if the cost approach practitioners are dealing a fair game. Market measurement errors affect the cost approach just like they do with the Direct Sales Comparison Approach.

However, the observed results from appraisers is that the cost approach indeed does tend to set the upper limit of value:icon_smile:

Therefore, the answer is: When appraisers are free to back into something, they tend to back in a bit high (observed).

It makes underwriters suspicious, kind of like seeing cows and Harvester silos along a "suburban" street scene, if the cost approach comes in low.