Cost Approach vs Value Opinion

[J Grant]

I have just completed a New Construction report and have an issue that I am mulling over. The purchase contract price for the subject (including lot) is $300,000+/- . My final opinion of value is at $250,000. My Cost Approach value is $325,000 (Marshall & Swift). I am trying to determine what factors are at play for the discrepancy between my value and the Cost Approach value. I am very confident that my value is accurate. Any thoughts?

First off, I agree with PE about economic obs.

To address above: new construction CA can be tricky. Appraisers use M & S or other cost service to reflect building one home and hiring labor/buying material at going rate. Builder cost can be far lower. They hire work crews rather than pay individuals. They buy building material in bulk at lower cost. They buy tracts of land and subdivide them, thus builder cost for a the land comprising a site was less than value of site as it is on the cost approach.

The OP value opinion was 250k his SC price contract for subject was 300k. That means borrower was paying closer to the cost approach which also explains the gap.

Can apply as others have stated obsolescence in market can be applied to cost approach... gaps and difference can be explained by lower builder price to build and land acquisition than M S figures and site values and that the CS price is not as far from CA as the value opinion is.

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[hastalavista]

Value = Cost - Depreciation

You are posting that the property's value is $250k and the cost is $325k.
If you are confident in those numbers, then you have $75k in depreciation.
Depreciation is a loss of value.
Obsolescence or deterioration (physical... like wear and tear) causes depreciation.
Since this is new construction, I'll assume there is minimal physical deterioration.
Therefore, what remains is functional or external. My guess is the same as the others: The significant factor causing a loss in value is external (economic) obsolescence.

 

[J Grant]

Value = Cost - Depreciation

You are posting that the property's value is $250k and the cost is $325k.
If you are confident in those numbers, then you have $75k in depreciation.

Depreciation is a loss of value.
Obsolescence or deterioration (physical... like wear and tear) causes depreciation.
Since this is new construction, I'll assume there is minimal physical deterioration.
Therefore, what remains is functional or external. My guess is the same as the others: The significant factor causing a loss in value is external (economic) obsolescence.

D- the above is why imo the CA can be a slippery thing .

Per OP market value opinion, the depreciation is 75k (loss of value). /however, if builder is getting 300k from other buyers (who may or may not be overpaying), builder is actually seeing only 25k obs/dep on typical sales of subject model. Then consider that actual builder cost and land acquisition can be far lower than M & S and site value on a CA.

Thus, it might have only actually cost builder 240 k, for example for portion of land as site and build cost of the subject, which means no depreciation. Which would make a CA close to the Market value opinion, if one could learn what builder "really" spent and apply those figures.

 

[Meandering]

If the property's value is $250k and the cost is $325k,

might I ask if there are other new homes being built in the area?

You're numbers suggest that there is no EP in the game for builders. So before I'd apply the mathematics for Ob, I would really look at the new home market and see what's going on.

If there are more new homes being built are they being financed? If not, you're going to have an Ob issue, when cash will pay the premium that financing won't.

If you are seeing a cash premium, you're looking at different submarkets, and you may have to adjust your sales upward as they might be in a different submarket.

It really is just dependent upon what is going on in the market area with other new homes, or if this one is an over improvement when compared to other brand new homes.

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[PropertyEconomics]

Economic obsolescence is a form of external obsolescence.

I understand thats the current "teaching trend" .. but economic obsolescence nearly always is curable with time .. and external (resulting from something proximate but outside the property boundaries) is not ... in my opinion they are vastly different and should be recognized as such.

I get it CAN I really do... but they are different .. and I wish they were recognized as such.

 

[J Grant]

I understand thats the current "teaching trend" .. but economic obsolescence nearly always is curable with time .. and external (resulting from something proximate but outside the property boundaries) is not ... in my opinion they are vastly different and should be recognized as such.

I get it CAN I really do... but they are different .. and I wish they were recognized as such.

Agree, and for consideration...if one can line item out depreciation (market loss as obs,), then why can't market appreciation be line itemed out, instead of blended in with cost to build or land value as EA?

Building costs and land prices may rise in a boom, but typically not as much or at same percent rise as seen in sale prices.

 

[CANative]

I understand thats the current "teaching trend" .. but economic obsolescence nearly always is curable with time .. and external (resulting from something proximate but outside the property boundaries) is not ... in my opinion they are vastly different and should be recognized as such.

I get it CAN I really do... but they are different .. and I wish they were recognized as such.

"curable with time" is not a technically correct way of treating this type of obsolescence. It's not "curable" because it is external. But it can be temporary.

And an experienced appraiser does recognize the difference. So the only thing I'm disagreeing with you is the need to make a separate "category."

 

[PropertyEconomics]

"curable with time" is not a technically correct way of treating this type of obsolescence. It's not "curable" because it is external. But it can be temporary.

And an experienced appraiser does recognize the difference. So the only thing I'm disagreeing with you is the need to make a separate "category."

Whatever ....

 

[hastalavista]

I understand thats the current "teaching trend" .. but economic obsolescence nearly always is curable with time .. and external (resulting from something proximate but outside the property boundaries) is not ... in my opinion they are vastly different and should be recognized as such.

I get it CAN I really do... but they are different .. and I wish they were recognized as such.

PE:

I don't have a problem with making economic obsolescence its own category and not a subgroup of "external" obsolescence. I think if that were done, it would result in more discussion and instruction on how to identify and quantify it (which would be a good thing).

On the other hand, "external" (IMO) is not just outside of the subject's site/area boundaries, but also outside of the control of the owner or user. Economic certainly falls into this category.

In the end, the cost approach model (value = cost - depreciation... and I acknowledge that Nelson Bowles, MAI, in his book "In Defense of the Cost Approach" really hammers the simplicity of the formula into the reader's brain) works, and works very well. The difficulty is always in the quality of the data.
In some cases it is extremely good; costs (hard/soft, EI, and site acquisition) are very accurate and all forms of depreciation can be measured with confidence.
In some cases, it isn't that good; the costs are fuzzy and (usually) the depreciation isn't that easy to identify and quantify.

To the OP: The quality of the data and the subsequent reliance on the CA in concluding the final value opinion must be discussed in the reconciliation section.
If I had a $75k gap between the SCA and CA where the value is somewhere around $250k to $300k, I'd do my best to identify what was missing and attempt to fill the hole with the missing data. But if I couldn't, I'd address that as a weakness of quality of data for that approach and not force an adjustment into the approach just to make the numbers similar.
With such a gap, I can think of no better reason then to give the CA very little consideration.
But again, if you are confident on your building and site costs, then I think there is some external (economic) obsolescence affecting the property.

Good luck!

 

[J Grant]

An option is for OP to explain gap as due to that CA figures appraisers get from M & S uses may not apply to builder cost for materials, labor, and land , which may be lower due to builder ability to buy supplies in bulk and acquire labor and land at advantageous prices. Thus the builder in actuality might not be in suffering the same % loss/ depreciation seen in the CA model on appraisal.