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Cost approach VS Market Value

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Mary Caffey

Thread Starter
Sophomore Member
Joined
Feb 22, 2002
OK there is a "discussion" going on in the office over the Cost Approach, Sales Comparision Approach and the Market Value ....


can you - should you, how do you give a different value amount for all three???

how many of you give the same value for the sales comparision approach as to market value and is there documentation for different value for each.


how do you reach the market value approach is you use a different figure than the sales comparison approach.

No income approach is used in this equation.

mary in texas
:roll:
 

rtubbs

Junior Member
Joined
Jan 15, 2002
Mary, I didn't know there was a market value approach to appraising. Market value is the result of reconciling one or more of the 3 approaches to value (cost, sales comparison, income).

Ignoring the income approach (as you stated) and without reciting definitions, theories, principles, etc., I typically conclude that, for residential properties, the market value is the same as the value derived from the sales comparison approach-and I hope the cost approach supports that conclusion.
 

Richard Carlsen

Elite Member
Joined
Jan 15, 2002
Professional Status
Licensed Appraiser
State
Michigan
Good question: Here goes an attempt to answer.

The URAR is set up to demonstrate a value based on each of the three approaches to value; Cost, Income and Sales Data. Since Income is most often N/A in a single-family house, we generally concern ourselves with the Cost and the Sales Data. Since we only are concerned with the Sales Data indicated value, we will only discuss that.

There generally are two means of arriving at a Sales Data indicated value. 1. A true comp within the sales grid that becomes the best indicator of subject's value or 2. The weighted adjusted sales price of all comps.

If you are doing an appraisal for the secondary market, they want the opinion of Market Value to be based on the Sales Data Approach. Therefore, if you come up with say $125,000 in the Sales Data Approach, you better have a good reason not to use it in the reconciliation as the Opinion of Value.

In private valuations or other appraisals, not intended for the secondary market, you can use whatever you want in the reconciliation to arrive at an Opinion of Value. I will often use the Cost Approach, which has a very high validity in my market, as an influencing factor in the final opinion of value. Here, the sales data approach value may be different than the final opinion of value.

I have, on occasion, where the cost approach better reflected the condition of the property or the effects of outside influences (external), stated the weighted adjusted sales price as the sales data value and then lowered the value in the reconciliation based on the influence of the cost approach. I have never been questioned on this. I am careful to state that the sales data approach is given the greatest weight with the final opinion of value influenced down by the cost approach to the lower end of the indicated value range of all comps.

Did I answer the question? It is has been a long 2 days and I have to go to the U.P. tomorrow.
 
A

Anonymous

Guest
Good answer. I personally think that statistically, when the comparables require large adjustments or adjustments that are somewhat vague. Like location, condition (after all many, if not most, of our comparables were not personally inspected inside by us, so aren't we guessing a little since all Realtors say the condition is GOOD unless it is falling down, then it is a FIXER UPPER!), etc. The sales approach may not deserve the weight.

The classic is the manufactured home on small site. 4 of the same age and, from the street, may look like the subject, but be higher or lower quality. In that case, if the records are not available to estimate accurately the comparables MH value via manf. & model name NADA style, then the NADA book PROBABLY will more closely estimate the market value because the bankers use the book, the dealers use the book. The NADA book is a hybrid with Costing out values based upon sales. As the MH classes usually teach. DO THE LAND & SITE IMP. VERY CAREFULLY, then add the NADA value of the MH.

I think one of the flaws of secondary market appraising is the strict adherence to the Sales Approach. Since so many complicated (if not complex by definition) houses want cheap interest rates, the underwriters drive you nuts trying to get you to tweak the appraisal to favor the dwelling and ignore everything else. Example, we are working on now.

1 + acre. 1 year old 1,900 SF dwelling, nice. Old shop on back side is a home auto repair shop, not worth much. But now the owner wants to build a $40,000 red iron shop building to replace it. Mixed use wanting a 2ndary market rate. We will catch grief for telling the truth. I do have a 3 year old house 2,100 SF, nice. And a $40,000 red iron shop...on 40 acres. What underwriter will accept the truthful adjustments required (a very large land adjustment)?
 

Restrain

Elite Member
Joined
Jan 22, 2002
Professional Status
Certified General Appraiser
State
Florida
Having worked directly with underwriters in a major bank, I know for a fact that the value they look at is the Direct Sales Comparison Approach. The only use they have for the Cost Approach is the Land/Value ratio and the Reproduction Cost New for insurance purposes. Realistically, the Cost Approach for a home that is over 10 years old is not applicable except for demonstration purposes. Housing desires and building types change and change rapidly. As to the Income Approach, unless the property is a rental, they don't want it in the report.

So, my thought is that is that for academic purposes all approaches should be used. Realistically, the Cost Approach becomes secondary and is usually backed into based on the Direct Sales Comparison Approach.
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
"realistically" only in the secondary market, underwriting world. I venture well over 1/2 of all loans deal with non-secondary market. I don't care if the dwelling is 40 years old, the Cost Approach can be both accurate and applicable. What applies in town may not in the country.

When talking with buyers, unsophisticated as they may be, they often view a rural property as land worth so much, dwelling is X old and X big and they compare that to what a new house would cost in town. Ditto for buildings. When my uncle sold the farm next to me the buyer said, I think the barns are worth $5000 each and the land is worth $1600 an acre. What was she describing except the Cost Approach? And if the market is examining the Cost Approach, so should we.

Land ratios are meaningless except to underwriters. I have reviewed a number of appraisals for secondary market where the appraiser deliberately degraded the land value well below its value so as to not get over the magic 30%. In one case the appraiser ventured the excess land to be worth $600/ac. in an area where similar land tracts were easily selling for over $4000/acre. But he hit the ratio!
 
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
Florida
Terrell,

That's the way I see it. In real estate sales, (farms, mostly) all the sales people in my office used what i would call a discounted cost approach.

Such as, how much would you give the land?
How much for the main house?
The manager's house?
The foaling barn?
The shed row barn?
The wells and fencing?

Add that all up and you have their estimate of value.

Thomas N. Morgan
Ocala, Florida
 

Will Granger

Sophomore Member
Joined
Jan 15, 2002
Professional Status
Certified Residential Appraiser
State
North Carolina
Time to go back and study your text books. Do the Market analysis first. The difference between cost new and market is depreciation from all sources. Good luck on quantifying physical, functinal, and external obsolescence. I can do it, but it takes a lot of experience. I'd rather go fishing now. :)
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
The buyer is "the market" and if you do not do what he or she is doing, then your market analysis is going to be flawed. We apply external and functional obsolescences to improvements, but 9 of 10 buyers will degrade the total property value for external obsolescences and ignore the value of over-improvements except as a nice selling point.

Yeah, anybody can determine the existance of functional or external obsolescences, but many of the most serious ones are unique to that single property and there is no way in God's Green Earth to "quantify" such items by using other property sales.

Example? Last year a property sold for $235,000 on 40 acres. Listed for $350,000 for 3 years after the owner was murdered near the property. About 4000 SF house. Functional? Windows were not designed to open and the house has only 2 bedrooms, one is about 1200 SF. Find me a similar house. Factor two. Very distant location from similar houses. Find me a house with similar functional obsolescence and far from an area with similar neighborhood. This house lays on the Oklahoma-Arkansas State Line. The local school is 15 miles away. The nearest incorporated town is 6-8 miles away in Missouri. The nearest houses are about 1 mile.

Paired sales are not going to help you. Cost to cure migh help you. But I interviewed the buyer and understood the rationale behind their decision to buy and the bank was helpful in determining how it was priced out. I guarantee I would rather "take that to the bank" than trying to use other sales to estimate the concession, the functional, and the external obsolescences. Stigma? No, the owner's murder was not a factor, but the screwy interior design was a BIG factor.

Ter
 

Paul Ness MAI

Member
Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
Terry, you stated something to the effect that anyone can determine functional or external obsolescence but most are unique to the specific property. If a property has problems, as the one you mentioned above, there is weakness across the board - not just in the cost approach. How did you determine adjustments in the sales comparison approach for the windows, bedrooms and bedroom size? Weren't those adjustments for functional obsolescence as weakly supported as would be estimates of depreciation in the cost approach? Many appraisers exclude the cost approach because of large and subjective estimates often required for accrued depreciation, and then turn around and make large subjective adjustments in the sales approach anyway.

You mentioned cost to cure, which is what I first thought of when reading about your 2-BR house. But in order to determine if something is curable you need to know how much value will be added from curing the deficiency - so you are right back to square one. I would think constructing partitioning walls and corridor in the 1,200 sq. ft. room to end up with three or even four BR's would be curable (the value added would exceed the cost) but I'm not sure about the windows.

I'm talking more about commercial appraisals here - but I see appraisers cop out and exclude the cost approach too quickly. If an appraisal is a "complete" appraisal then the cost approach must be considered every time and applied more often than it is. In sad reality, I think the two main reasons it is excluded more than it should be are (1) many appraisers don't really understand proper methods of estimating and applying accrued depreciation, and (2) appraisers' fees are being beaten down so much that it's a quick way to cut out some work. Hmmm, I smell the makings of an article here.
 
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