Extraction Method

[CANative]

Be a great thread to start. And to clarify, IF: (a) the appraiser has an accurate assessment of site value, (b) an accurate assessment of RCN, (c) an accurate assessment of accrued depreciation from all forms (P,F,E), and (d) an accurate assessment of the contributory value of the site improvements, then I'll grant that the cost approach MIGHT return a meaningful estimate of market value. To djd's point, though, even the term 'market' in the type of value being appraised infers sales comparison (i.e. what the 'market' is doing). I would submit that the amount of research necessary to truly obtain accurate assessments of a, b, c, and d, make the cost approach prohibitive to perform, AND if an appraiser performs the cost approach without an accurate assessment of ALL of a, b, c, and d, he/she is potentially producing misleading results.

Here's what I think. Those appraisers who say the cost approach can be misleading, not "truly accurate", meaningless, and other expressions like this is are, at best, rusty with the cost approach to value. I think what they are saying is that the cost approach doesn't always come out the same as the sales approach. And that sets up a conflict they can't explain, or don't want to slow down production to find out why and then explain it to their client. They think it weakens confidence in the sales approach. And that, my senior appraiser friend, IS misleading. Because a proper cost approach can take the temperature of the market from a different, and more subtle, perspective of market conditions. I say it has the potential to be predictive.

Those who try to force the two approaches to agree with each other did not do a cost approach. They just did another sales approach and labeled it a cost approach.

The issue, IMHO, is that cost approach naysayers are not including entrepreneurial incentive in their costs (and certainly not as a line item of cost.) It MUST be taken into account because developers don't develop land without the prospect of making a profit on their time, risk and money. Even in markets where there is no building going on due to limited availability of undeveloped lots or market conditions are such that the cost exceeds what the market will pay, EI, as an allowance, has to go into the costs bucket. When the CA varies significantly from the SA, it is probably the external obsolescence caused by market conditions and should be accounted for. If the SA is WAY higher it might mean that excess profit is occurring and that might mean an instability in supply and demand that could lead to adverse conditions on the horizon (like 2005 to 2007.)

I typically include 10% to 15% of total costs (land, building, permits, entitlement, etc.) as a reasonable allowance. If that all works, then I would say the market is currently stable. Trust me, uderwriters and "Chief Appraisers" at real banks want to know this and either demand or appreciate the cost approach.

 

[djd09]

yes profit another subjective data point. keep going.

 

[alebrewer]

Until you know cost to build please explain how to determine economic obsolescence?

So, in general, the preferred way for me to determine economic, or external, obsolescence, is paired sales - extracting the difference in value between a sale that exhibits the obsolescence and one that doesn't. Another method that I've used is to capitalize the rent loss, again between a property that exhibits the obsolescence and one that doesn't. This VERY DEFINITELY would be an area, though, that I would admit to being VERY coachable if someone can demonstrate that those are not appropriate methodologies for estimating external obsolescence...

 

[Zephyr999]

and misleading is misleading. i can change whole markets with the CA.

my new policy is i do not answer questions.

You can pull the same wammy with any of the approaches...cost may just be most obvious as it's broken out.
It's fair to avoid answering questions...P.S. purple koolaid was my fav

 

[BRCJR]

cost does not equal value. this has been proven over and over throughout history.

in one hand USPAP says an appraiser must not communicate assignment results that are misleading but

in the other says you can develop misleading assignment results and give no weight to them. FAQ 302. Go figure.

...a better comment is, "cost does not always equal value", because sometimes it does.

 

[alebrewer]

Here's what I think. Those appraisers who say the cost approach can be misleading, not "truly accurate", meaningless, and other expressions like this is are, at best, rusty with the cost approach to value. I think what they are saying is that the cost approach doesn't always come out the same as the sales approach. And that sets up a conflict they can't explain, or don't want to slow down production to find out why and then explain it to their client. They think it weakens confidence in the sales approach. And that, my senior appraiser friend, IS misleading. Because a proper cost approach can take the temperature of the market from a different, and more subtle, perspective of market conditions. I say it has the potential to be predictive.

Those who try to force the two approaches to agree with each other did not do a cost approach. They just did another sales approach and labeled it a cost approach.

The issue, IMHO, is that cost approach naysayers are not including entrepreneurial incentive in their costs (and certainly not as a line item of cost.) It MUST be taken into account because developers don't develop land without the prospect of making a profit on their time, risk and money. Even in markets where there is no building going on due to limited availability of undeveloped lots or market conditions are such that the cost exceeds what the market will pay, EI, as an allowance, has to go into the costs bucket. When the CA varies significantly from the SA, it is probably the external obsolescence caused by market conditions and should be accounted for. If the SA is WAY higher it might mean that excess profit is occurring and that might mean an instability in supply and demand that could lead to adverse conditions on the horizon (like 2005 to 2007.)

I typically include 10% to 15% of total costs (land, building, permits, entitlement, etc.) as a reasonable allowance. If that all works, then I would say the market is currently stable. Trust me, uderwriters and "Chief Appraisers" at real banks want to know this and either demand or appreciate the cost approach.

Hope you're not implying that I'm a Chief Appraiser at a 'non' real bank... I'll go with the assumption that you're not, as I most definitely work for a 'real' bank. And no 'real' bank I've ever worked for is interested in entrepreneurial incentive. That said, I'm sure that banks who do interim construction loans very well might be interested in that - that's something I cannot address as I've never been in that environment.

Absolutely agree that those who try to force the two approaches together haven't done a cost approach. Would you agree though, that if you've absolutely nailed everything perfectly in both approaches, they absolutely would agree? IOW, if there's a difference, you've done something wrong on one or the other (or both) approaches?

And it doesn't add meaningful thought to the conversation to project your opinion that cost approach naysayers are, in your words, at best rusty with the cost approach to value. Instead of projecting your opinion of what you think I might be saying, just ask me, and I'll tell you what I really am saying.

For the record, here is what I really am saying: "And to clarify, IF: (a) the appraiser has an accurate assessment of site value, (b) an accurate assessment of RCN, (c) an accurate assessment of accrued depreciation from all forms (P,F,E), and (d) an accurate assessment of the contributory value of the site improvements, then I'll grant that the cost approach MIGHT return a meaningful estimate of market value. To djd's point, though, even the term 'market' in the type of value being appraised infers sales comparison (i.e. what the 'market' is doing). I would submit that the amount of research necessary to truly obtain accurate assessments of a, b, c, and d, make the cost approach prohibitive to perform, AND if an appraiser performs the cost approach without an accurate assessment of ALL of a, b, c, and d, he/she is potentially producing misleading results."

 

[CANative]

Now that would be an interesting take by a lender. Not sure who'd be on board with that, but there may be someone out there willing to lend based on the cost approach for residential properties...

I have a couple of community bank clients who require separate opinions of "Replacement Value." I provide those separate from the cost approach. Replacement value can be different depending on if they want it for fire hazards or flood hazards. I provide this in separate narrative pages that are "signable."

 

[CANative]

You can pull the same wammy with any of the approaches...cost may just be most obvious as it's broken out.
It's fair to avoid answering questions...P.S. purple koolaid was my fav

They didn't actually drink Kool-Aid. They drank Flavor-Aid. So even that bit of name calling is predicated on inaccurate information.

 

[CANative]

Would you agree though, that if you've absolutely nailed everything perfectly in both approaches, they absolutely would agree? IOW, if there's a difference, you've done something wrong on one or the other (or both) approaches?

No, I would not agree with that. Do all the comps adjust to the same indication of value?

 

[alebrewer]

No, I would not agree with that. Do all the comps adjust to the same indication of value?

If you've accounted for every nuance accurately, they do. Problem is that we cannot account for every nuance accurately, thus the 'adjusted' range of value. Same with comparing the two approaches - the reason they end up different is that we're not able to capture every facet accurately.