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Cost Approach Must Be Within 10% Of Mv

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Bob Hood

Freshman Member
Joined
May 25, 2002
I have really run into a problem. I have been really raked over the coals because I used M & S and the Real Estate Tax Assesment for Land in my cost approach. I have since adopted the Allocation method to adjust the site value up, however, I am being told that my cost approach must be within 10% of the Market Value I have arrived at. This is a central Maryland appraisal.

I know that I can do some reasearch to come up with higher cost numbers by talking to local contractors and then applying these percentages to M & S. I thought by doing the cost approach the way I was originally doing them that it would show the overexposure of the market and the LO could use this as part of therir portfolio evaluations.

My question is...........

Is there a stated or unstated guide line to push the Cost Approach number to within 10% of your Final Market Value? OR As a matter of practice do you attempt to get the cost number as close as you can to the MV? I have gotten some guidence that as a matter of practice in Maryland that you have to get this cost fairly close or the LO will bounce the paperwork back for having too wide a difference. I just need some advise on the subject. Thanks for all your help I don't know what I woud do without having this board to review.

Thanks

Friday Morning 9:00AM
I have been reading all of your fine comments and I can't tell you how much it has helped. I took special note of reading what was excluded in the M & S cost figures. I made a dozen calls to area builders. Only two or three have called me back with any usefull information. I called my old instructor and another local appraiser and was also given some assistance for my files.

The result was that I worked twelve hours over that night and revised all the cost approachs to a MORE current and market driven number. NOT Just Plugged. I wrote a full page letter on the subject and submitted the revisions. In the end the client will not be using me, but I figure that it would have probably come to a bitter end at some time in the future anyway. At least I really did the right thing and within 24 hours of notification. Some lessons are more expensive that others.

Thanks Again. :redface:
 

Ron in AR

Sophomore Member
Joined
Jan 16, 2002
Professional Status
Certified Residential Appraiser
State
Arkansas
I don't know of any such rule. Of course, we would like for all of the approaches to agree, makes our job easier but the cost approach stands alone and indicates value independent of the other approaches.

The difference in the cost and market approaches could be an indication of something going on in the market. I would think the UW would want you to shoot it straight.

If you could document something other than M&S with local costs, I don't see a problem with that either, it is what it is. But, to say it has to be within 10% of the market - what good is the approach if you're just going to force it?
 

larryhaskell

Senior Member
Joined
Apr 23, 2002
Professional Status
Certified General Appraiser
State
Nevada
Bob:

The three approaches to value are just that. Three distinct approaches utilized to determine the value of a property. In a perfect world, the conclusions of all three approaches would be identical. As I'm sure your aware, the older the improvements, the less reliable the Cost Approach becomes. There are a number of sources at your disposal to estimate the reproduction costs. However, I would suggest you don't mix the sources. If you use M & S, why would you use local contractor's costs unless you believe them to be more accurate. Pick and quote the source you use and that should be good enough. Same thing with estimating the depreciation.

Forcing the Cost Approach to be within 10% of the Sales Comparison Approach if it isn't correct is misleading. Don't do it. You have to remember that people who use our reports want them to be squeaky clean with no issues. Again, that would be a perfect world which isn't reality.

Complete your report as accurately as you can. Submit the report and move on to the next one. It isn't your job to make the UW's job easier.

Good luck.
 

Phil Rice

Member
Joined
Apr 22, 2002
Professional Status
Certified Residential Appraiser
State
Colorado
Bob:

There are 2 schools of thought on the cost approach. Some appraisers think it is meaningful and relevant, others think it is irrelevant and not worth spending very much effort to get it "right".

I have looked at the work of many other appraisers, and my conclusion is that they (almost) always value the home with the market approach and work backwards to make the cost approach = the market approach.

If you have 2 or more recent sales of similar sized lots in the same neighborhood, you know the value of your land. IMHO, it is darn near impossible (in my area) to get an accurate value on the land, because there is very limited (read none) market data on vacant land, and if you find anything, it is not comparable. If the subject is more than 2 or 3 years old, depreciation is nothing but a guess. And the cost of construction is an estimate at best, plus or minus 5%.

Builders do not price their homes based on cost. They price their product the same way that you price yours. They charge as much as they think they can get, based on supply and demand.

In your area, how does the typical home buyer decide how much they are willing to pay for a property? If that home buyer was able to pay cash and was willing to wait, would they have the option to buy a vacant lot and build their own? If that option does exist, how does this influence the market?

How does the cost approach affect your opinion of value? If it matters to you, then by all means, take it seriously. If you feel comfortable that you can value a property with the market approach (I think that is what you did), my advice is do not get trapped into spending a lot of time and energy trying to do a perfect cost approach.
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Phil,
There may be a third school of thought. Cost is not value.

However, to answer the original question, there seems to be a perfectly legitimate way of getting the approaches to come out exactly the same. The appraisal dictionary defines accrued depreciation as the difference between cost and value. There you go. Just subtract. If cost new is 120K and value is 100K, then the accrued depreciation MUST be 20K, right? Say its pro forma and give it no weight.

I don't think that violates any rule only the sensibilites of those who believe in the cost approach. :D
 

Ben Vukicevich SRA

Senior Member
Joined
Feb 9, 2002
Professional Status
Certified General Appraiser
State
New Jersey
Bob,

My first choice would be to ask the LO if the loan was electronically underwritten by FNMA or FHLMC. If it was, do a 2055 and get rid of the Cost Approach :D :D

Second, are you applying all of the allowable bump-ups to Marshall Swift?? Such as the National and Local multipliers? How about the marketing fee/expense which could be 6% or 7%?. Even FHA requires that you add a marketing expense to MS for their deals. That would get you closer. How about building permit fees, including water and sewer?

You should be well over that 10% you need with this extra stuff :blink: :blink:

Ben
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
Bob- the cost approach does not have to agree, but I find that if done correctly it should agree with the other approaches. All applicable approaches should be reasonably agreeable.

Real Estate Tax Assesment for Land in my cost approach
That's one clue I suspect your value has such a wide variance. I don't rely upon assessed values for nothing but calculation of the tax rate. 2nd - in the absences of vacant land sales, I suggest you have underestimated the land value. Is it illegal for someone to buy an individual lot in your community? Does no one anywhere in that market buy a lot and build their own home? I have heard of such, but I have never been in a market where that was the case.

work backwards to make the cost approach = the market approach.

Actually I often am inclined to do the opposite on farms....do the Cost Approach first, then check it against the market approach....I also follow up when properties not on the market at the time later sell, and adjust accordingly. I don't miss by much very often.

Builders do not price their homes based on cost
I suggest you live in a wildly inflated market, soon-to-burst-bubble, if prices are completely out of whack with cost. Competition has to be suppressed for prices not to fall to the lowest common demoninator. A builder explained to me for spec houses, he charged the lot sales price + impact fee + Cost + 8%. That was his set fee until Costs increased enough to erode his 8% to 6%, at which point he raised the fee back to 8%. He sells 100 - 130 / year. If that is not costing them out, then what is?

The old saw taught in my classes was that the Cost Approach would lead you to the highest indication of value. (that because few improvements are the perfect Highest & Best Use, thus you underestimate the functional/ external obsolescences leading to a higher value.) However, in your case, it appears the opposite is occuring. If this is a custom house, you may have underestimated architecture fees, builder fees (impact, building, utility, etc.) which vary from community to community. Are you sure you have allowed enough for builders risk, selling and holding costs (i.e.- discount for marketing time and add real estate commission) and contractor profits, too? Read the M & S sections related to those costs carefully.
 

charlie hill

Sophomore Member
Joined
May 4, 2003
Professional Status
Certified Residential Appraiser
State
North Carolina
Then what would you do with a case like I had recently? Ocean front lot that sold for $550 k and a 3000 sf raised beach house which has been built several times by the same builder for less than $100 a foot. That indicates a cost approach at roughly $850,000. I've got comps on top of comps of similar new and 1 or 2 year old sales on the same beach selling for $1,000,000.00 to $1,250,000.00.

You don't need to be backing into any numbers on any approach. Do what you can verify with market data. Document it in addenda. Keep good records. Don't worry about what the underwritter says. When the state licensing board calls you on the carpet to explain and document you work you will be glad you did.


By the way. The guy is not even through framing the beach house yet and has an offer for $1,250,000.00
 

Mike Garrett RAA

Elite Member
Gold Supporting Member
Joined
Jan 14, 2002
Professional Status
Certified Residential Appraiser
State
Colorado
Just finished an appraisal where the cost was nearly 18% below the present market. Quite typical in areas of older homes. I do agree, in most cases, the cost approach should be a reflection of the upper end of the value range. Most errors I find are incorrect land value and not handling the depreciation correctly.
 

Willie

Senior Member
Joined
May 30, 2002
Professional Status
Certified General Appraiser
State
Tennessee
Bob, you may be off on your land. Also, probably off on your effective age. The effective age reflected by the market should bring the cost approach in line with the sales comparison approah. In effect, the Cost Approach is tied in very heavily with the sales comparison approach because the effective age is extracted from the market.

Just blabbing here, I finished on up on an almost new home in an area of 30 year old homes. They were all the same size. Initially it appeared that the Cost Approach showed much more than the market approach. Land value is the same. What is the difference. The old homes brougt the effective age of my new home in line with their effective age. You have to extract the effective age from the market, in the Cost Approach, again, and that should bring it in line with the Market Approach.

And in Charlie Hills example, something is off. I don't know what. But why would anyone build pay $1,250,000 when they can build it for $850,000? Something isn't right because most folks just don't through away $150,000 to $400,000. Would you. Not me. To few details.
 
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