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Cost Approach on Condos? Only 1 approach to value IMO

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rdennistompkins

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Jan 6, 2004
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Certified General Appraiser
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Illinois
Didn't you get the memo? There is only 1 approach to value in my opinion, the market approach.



Think about it. Appraisers are paid to interpret the market, not make the market.

The income approach to value is a subset of the market approach. Sales price divided by market rent = income multiplier. Market rent divided by Sales Price = cap rate. That is a market approach called the income approach



The income and the sales prices come from the market so the income approach is a market approach.



Same for the cost approach. Where do we get land value? From the market. Where should we get the cost new? From the market. IF Marshall Swift does not represent the market in your area, you should not use it. Where do we get physical, functional and external obsolescence factors in the cost approach? FROM THE MARKET.



So my conclusion is that there is only one approach to value and that is the market approach. Why doesn't anyone besides me teach it this way? Why doesn't any book demonstrate that there is only one method to value and that is the market method/approach and the cost, sales comparison and income approaches to value ALL COME FROM THE MARKET? I don't care if you use a discounted cash flow, cap rate, monthly gross rent multiplier, annual multiplier, cost analysis and data, EVERYTHING COMES FROM THE MARKET AND WE ARE HIRED TO INTERPRET THE MARKET.



Now, I also believe that the cost approach is an exercise in futility in 99% of the cases. If you cannot get a REASONABLE SUPPORTABLE METHOD TO ESTIMATING SITE OR LAND VALUE, how in the hell is the cost approach applicable or meaningful? IT IS NOT ACCORDING TO PAGES 30 AND 31 OF USPAP Q AND A 2004. IF YOU DO NOT HAVE MARKET SUPPORTED ANALYSIS FOR THE PHYSICAL, FUNCTIONAL AND EXTERNAL OBSOLESCENC IN THE COST APPROACH, HOW IN THE HELL CAN YOU USE IT?



HOW IN THE HELL ARE YOU GOING TO GET A LAND VALUE ON A CONDO? YOU CANNOT, THEREFORE IN THAT ASSIGNMENT THE COST APPROACH IS MEANINGLESS, MEANING YOU COULDN'T USE IT IF YOU WANTED TO EVEN THOUGH THE CLIENT DEMANDS IT, NO APPRAISER ALIVE COULD USE IT AS IT IS WORTHLESS. IN 99% OF THE CONDOS, DON'T THEY OWN 1/100TH OR 1/200TH OF THE COMMON AREAS LIKE POOL, TENNIS COURTS, COMMON GROUNDS, CLUB HOUSE, ETC? AND CONDOS ARE BUILT MOST OF THE TIME ON A MULTIPLE SCALE. WHO IN THE HELL EVER BUILDS ONE CONDO ON A FEE SIMPLE LAND PLOT? AND NOW YOU ARE MIXING PARTIAL INTERESTS AND ASSIGNING A PARTIAL INTEREST IN A POOL TO THE INDIVIDUAL UNIT? HOW MANY TIMES HAS THE PARTIAL INTERESTS IN THE POOL OR COMMON AREAS ACTUALLY SOLD? NEVER. OOOPS, CAN’T USE THAT APPROACH THEN COULD YOU?



CONSEQUENTLY, THE COST APPRAOCH IS WORTHLESS AND SHOULD BE EXPLAINED AS SUCH AND NEVER USED ON A CONDO.



Now don't get me wrong, in certain assignments, the cost approach is important. REO's, as repaired, as fixed up, new construction most of the time, and some assignments where there are no sales within 10 miles but good market data on cost new and land values.



I ask my students every time I teach a class how many people are real estate agents. In each class there are quite a few appraisers who also have a real estate license to sell. No one who sells real estate has answered the question affirmative when I ask how many times in their careers have buyers or sellers actually employed the cost approach when making the buying or selling decisions on homes over 1 year old. Never, not once in millions of sales transactions, then I feel the cost approach is worthless. The market is telling us that the approach is worthless. The clients wants the cost approach to use for different reasons i.e. insurance value.



I used the cost approach a few years ago and the cost approach came in at 101,500 rounded. The sales comparison came in at 105,000. I appreaised it for $105,00 and the client went nuts. HOW CAN YOU APPRAISE SOMETHING FOR MORE THAN THE INDICATED VALUE VIA THE COST APPRAOCH.



OF COURSE, I SAID, DIDN’T YOU READ THE DAMNED REPORT? I GAVE LITTLE OR NO CONSIDERATION TO THE COST APPROACH IN FINAL RECONCILIATION. I ONLY DID IT BECAUSE THE CLIENT DEMANDED THE APPROACH AND WHERE IN THE HELL DOES IT SAY IN ANY PUBLICATION THAT THE COST APPROACH HAS TO BE THE HIGHEST INDICATION OF VALUE? WHERE, SHOW ME WHERE? IT IS AN APPROACH LIKE ANY OTHER APPROACH, IT COMES FROM THE MARKET, IT DOESN’T SET THE MARKET VALUE, IT DOESN’T SET THE UPPER LIMIT TO VALUE. WHERE IN THE HELL DID YOU GET THAT NOTION?



Just my opinion.



Now you can flame me for my opinions.



Dennis Tompkins

CEO The appraisal Academy

Midwest Valuation Group, LLC
 

Carnivore

Elite Member
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Jan 15, 2002
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State
North Carolina
It does amaze me that request for condo cost approach come from Lenders. Now AMC's I can understand, because those phone monkeys dont know any better.

My best client ask me one time how to deal with Condo Insurable Value. I explained to them the best method was to get the Homewoner to acquire that number form the Insurance Agent. I also informed them to make sure they had a copy of the master policy.

I told my client that I would be glad to get all that for them for a price ($100 bucks). I recommended that they not go that route unless it was absolutely necessary. The cheapest way was to allow the HO get it for free. Since myself and the HO would take the same steps it made sense to them.

She thanked me. Today, this client is one of the reasons I can stay afloat in this market. They are very loyal to my service model.
 
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Marcia Langley

Senior Member
Joined
Aug 26, 2005
Professional Status
Certified Residential Appraiser
State
Missouri
dennis,

I don't think anyone here would argue with you about the cost approach not being suitable or credible for single family units in a condo.

I really wouldn't argue with anything you say except that the three approaches to value are defined in USPAP and all have their place as an appropriate approach to market value depending on the assignment.

Appraisers here debate the relative value of the approaches quite animatedly in these forums. You are preaching to the choir.

If you could educate our clients we would be grateful.:rof:
 
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Fred

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Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
dennis,
I don't think anyone here would argue with you about the cost approach not being suitable or credible for single family units in a condo.
I wouldn't argue that it is "suitable," but I would argue that it is not less suitable than for most other property.
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Why doesn’t any book demonstrate that there is only one method to value and that is the market method/approach and the cost, sales comparison and income approaches to value ALL COME FROM THE MARKET?
I can only tell that you that I wouldn’t teach it that way, because it isn’t true. If the cost approach is being used to estimate insurable value, then it is not “from the market.” If the CA is used to estimate deprival value, then it does not “come from the market.” Sure, market value is important, but it is not the only type of value. Multiple methods have evolved because there are many types of value and many types of property. It may be customary to say this the other way around, but if you think every problem is a nail, all your tools will look like hammers.

Even within the MV context, it is not clear that the cost approach has to come from the market. In the other approaches, it is likely that an appraiser will conclude that value is the going rate for that type of property interest. The CA has its own rules and principles that seem to suggest the going rate is not market value, if market value exceeds cost. And “cost” does not “come from the market.”

Something else that is not taught is right out of the TAF Body of Knowledge, in the “Roots” section. It mentions the “neo-classical” school and the “Austrian” school of economics. If there is anything significant to practical valuation to come out of that history, it is that the cost approach and sales comparison approach are rooted in contradictory value theories. Any argument that they are the same, is in my view, ill founded and bouind to run amok.

It is possible to use cost as unit of comparison in sales comparison. This is shown in the 10th edition on page 362. However, I don’t see this as an application of cost approach principles and even the 10th edition calls it “sales comparison.”

HOW IN THE HELL ARE YOU GOING TO GET A LAND VALUE ON A CONDO? YOU CANNOT,
While I see little to no relevance for the cost approach with respect to market value and I don’t’ use the approach, I could never understand those who draw the line at condos. In “reproduction” you might want the exact value of the subject site, but in “replacement,” you can use the value of a replacement site.
 
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David Wimpelberg

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Mar 30, 2005
Professional Status
Certified General Appraiser
State
New York
Hi Dennis,

I'd just add that you're referring to market value. The cost and income approaches can stand on their own, say in insurable and investment value, respectively.

In the literature, the cost approach to market value for a condo requires determining the cost of the land under the complex, as well as the cost of the common elements, and determining what percentage is attributable to the subject. That is clearly ridiculous; your typical unit buyer does not price a unit that way. It also very complex and outside the scope of practice of a residential appraiser.

A cost approach on a complex could be done for insurable value. We just quoted a fee on one. Let's just say that the fee would give the average residential lender a myocardial infarction, and that's without determining the land value.
 

Stephen J. Vertin MAI

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Jan 17, 2002
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Certified General Appraiser
State
Illinois
Oh my Lord not the cost approach again?:Eyecrazy: Dennis did Steve and David pay you to start this string?:rof:
 

AppraizinAZ

Junior Member
Joined
Dec 31, 2006
Professional Status
Certified Residential Appraiser
State
Arizona
Dennis,

Thanks for the good points and quotes to use when asked stupid questions by phone monkeys...well put and thanks!
 

David Wimpelberg

Moderator
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Joined
Mar 30, 2005
Professional Status
Certified General Appraiser
State
New York
Oh my Lord not the cost approach again?:Eyecrazy: Dennis did Steve and David pay you to start this string?:rof:

:)

There is not only plenty of literature out there against using the cost approach to market value, but there is also literature out there about one approach to value.

I don't necessarily agree that the income approach is an extension of the sales comparison approach. In residential appraising it basically is because of the GRM methodology and all the requirements for using it. But in strictly income-producing properties, purchasers are interested in various returns and risks levels, and price/buy properties on that basis. I've come across several properties where direct comparison is simply not possible, often because of mixed use/mixed zoning with HBU as improved, but can determine the market value based on how market participants price the income stream.
 

Stephen J. Vertin MAI

Senior Member
Joined
Jan 17, 2002
Professional Status
Certified General Appraiser
State
Illinois
There is not only plenty of literature out there against using the cost approach to market value, but there is also literature out there about one approach to value.
Only playing with you old buddy. You and Steve are to dedicated towards the cause for me to take on alone. Peace.
 
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