Interesting personal thinking from an insider...

[Restrain]

I would argue that the Cost Approach for a 1 year old home in a subdivision where the builder is still selling creates an inaccurately high value. This requires a significant downards adjustment for the 1 year old home vs. the new home. This is because the builder hides significant concessions in the new home price that cannot be replicated in a resale. This is very apparent in paired sales which creates an economic obsolescence of as much as 10% in an existing home vs. a new home.

Therefore, while the Cost Approach can be utilized, as with any approach, appropriate market input must be utilized, not just a reliance on published cost guides and depreciation guides.

Just a thought.

Roger Strahan, SRA

 

[Fred]

John SRA posted,
"Few things disturb me more than looking at reports where it is obvious that the appraiser simply backed into a cost approach without doing any real research. "

Let's say, I agree. So, how do you reconcile that peeve with this excerpt from the Dictionary of RE Aprpaisal -
"Depreciation: any difference between reproduction cost or replacement cost and market value as of the date of appraisal."

Does this definition actually call for backing-in; or at least support or imply backing-in? Would it be fair to say that any method that derives a number for depreciation that is not equal to RCN-V is, 'by definition', incorrect?

 

[Mike Garrett RAA]

Well said...George!

 

[Tawfik Ahdab]

Every single one of you has some important thing to say about these complicated topics, which strike at the heart of appraisal theory and practice.

The cost approach is applicable as long as there is limited and/or well -quantifiable depreciation. Advocates of the cost approach seldom emphasize the difficulty of correctly discerning, and apportioning depreciation among, its three components. A typical residential problem is a high-end home. If the reproduction or replacement cost is higher than the market value derived from the application of the sales comparison approach, could that not be due to an externaility due to the lack of buyers in that price range rather than owing to superadequacy?

The income approach is significant only if reflects the typical purchasing investor's intentional relation of income to value. Short of that, this approach is either problematic, of very limited reliability, or altogether of meaningless application to single family residential properties. However, like the cost approach to value, it can be an indispensible aid as a test of reasonableness of the value conclusion derived from the sales comparison approach, and may be applied more often to certain complex residential properties than it is given credit for even among experienced appraisers.

The sales comparison approach is the preferrable indicator of value for properties displaying an active market for competing or comparable properties, or for other residential properties providing at least average hope of liquidity to the seller. It is the "sine qua non" techique for appraising properties in accordance with the definition of market value, and, as a valuation approach, will stand alone in light of good comparable market data requiring adjustments within acceptable magnitudes. iT is hard to beat when the market data demonstates that you subject's value estimate can be demonstrated by ample, indisputable, comparable, and timely sales.

That being said, there are many refinements within these statements to accomodate the view expressed by you all.

Tawfik Ahdab

 

[Ben Vukicevich SRA]

Hmm..

Got to get in on this one. You all know my feelings on the Cost Approach for any home, new or existing...the appraiser is NOT qualified to complete it and in most cases, probably violates the Competency Provision of USPAP by doing so, along with issuing a misleading report as the end result. Scary thought, huh?

Very few appraisers are recognized cost experts and unless you're an architect or licensed builder, I'd expect you could get into big trouble with the Cost Approach if taken to task on it. We are recognized valuation experts, however. So, bye bye, Cost Approach. Lord I am thankful that Fannie and Freddie know USPAP better than we do and have trashed the Cost Approach on the 2055's and 2065's. I'm glad someone is looking out for we appraisers.........and keeping us out of trouble with USPAP and the state boards.

Sorry guys, it can't be done...competently as per USPAP...

Whoops I have to add...welcome back Tawfik!!! One of the original appraiserforum guys from wayyyyyy back. Now where is Mike Boyd???????

Ben

 

[Austin]

In doing the cost approach, most appraisers rely on the Marshall & Swift Manuals as their standard source for doing the cost approach. About 12 years ago I took the Marshall & Swift Cost seminar that was given locally. The scheduled teacher had a death in the family so they sent the man that puts the book together and who was and I believe still is the head-honcho whose name is Richard Litnoff sp. I got to talk with him one on one and then I had lunch with him that day. He really gave me some insight into the cost manual that I would not have received otherwise and this insight is the basis of my views on regression, cost approach etc.
I remember him explaining that those cost classifications sections are each the center of a bell curve with an over lapping variance of +- 10%. The significance of that fact is that if you never interpolate and market test the manual against local cost then you are most definitely doing it incorrectly. Years ago I invented a system to align the cost manual. I divided the manual up by numbering each cost classification and subdividing the range between classifications into tenths. For example, a fair quality was a 2, average quality a 3, and the distance in between were on the order of 2.1, 2.2, 2.3, etc. Then every time I did an appraisal on new construction I did cost iterations to determine the exact cost classification like 2.3 for example in relation to size of buildings. Then I kept a running graph of size or GLA vs. quality of construction number and calculated a trend line. There was a very good pattern with small variance. Larger houses had better quality construction and when I did an appraisal using the cost approach I would just look at the graph and say: This house has 2,000 square feet and in this market 2,000 square foot houses are a 3.3 quality rating. Then I could interpolate between 3 & 4 quality cost factors with a well supported market and cost manual cost estimate.
This in significant and to point out the significance I once did a graphical analysis of the entire cost manual. What I found was that say for example, a 1,000 square foot dwelling. The basic cost factor per square foot ranges in the manual from $25 to $140 per square foot across the quality range. That is a wide range and if you don't have some system to narrow it down to within $2 per square foot, then you are wasting your time doing the cost approach and never in my career have I seen a system other than the one I just described to do that. I remember Richard Litnoff telling me that people would call Marshall & Swift to ask a question and after asking the question say: "Hey, while I have you on the line, what are those green pages in the back of the book for?" These were people that had been using the cost service for 10 years and never once made a local index adjustment or updated to the new cost index for the interim period thus being up to 15% or more out of kilter.
In summary: The cost approach is an important valuation tool, but the state of the science of appraisal when using this tool precludes its use in most instances. The average appraiser is not going to the trouble of doing it correctly. I use Marshall & Swift cost manuals all of the time but I have never used them except to report what I already know the market cost are.

 

[Mike Garrett RAA]

Tawfik......welcome back.

My brother, an SRA also says the same thing....misleading. Unfortunately or fortunately, which ever applies, it is still part of the core curriculum in all real estate appraisal courses and text books. It is required to be included per state regulation (in my state). So, I have no choice but to support it.

 

[Verne Hebert]

Tawfik addressed Santora's with regard to "depreciation" nicely, I thought.

I concur with Ben--estimating is a profession in itself. Unfortunately, there are few appraisers that can comfortably produce a cost approach to value. And it is unfortunate, it can bring to light many qualities and elements of the property, in aiding in the final reconciliation.

With regard to Austin's response, appraisers use M&S because it has been considered a standard ot the Appraisal profession--and I suspect that is why, plain and simple. I too use it for most assignments.

However as an estimator, the use of M&S is almost unheard of--and probably for no particular reason.

But I'll tell you a story. After appraising for a number of years and putting myself through college using M&S. I later started a commercial construction company. I was on a "job walk" to bid a government project. Of the the estimators walking the job and I were talking. One of the components of the job was unusual and neither of us had any good data. He said, "I'll just get it out of M&S". I said you bid out of M&S. He said "ya. If you can't make money on those numbers, you'd better find something else to do!".

After using M&S for over 15 years, I never thought of it as a true construction cost guide, but a cost guide standard for the appraisal industry. Their costs are developed just like everyone elses however. Real field data.

 

[Dale Smalley]

The cost and income approaches are by products of the market approach. You still need to know market value of the land and market rent. If used properly they should support the market value approach. And to do it right with all the research and verifications we would have to charge about $1000 to be worth the effort.

In reviewing I look for high Land to value ratios and higher than normal land improvement numbers. But most of the time there is no rent schedule to review so you kind of just have to feel if it is reasonable or not. I cosider a good appraisal to rely most weight on the market approach to value and supported with the cost and income approaches. When all three come together it is hard to knock that opinion.

 

[Farm Gal]

I would argue that the Cost Approach for a 1 year old home in a subdivision where the builder is still selling creates an inaccurately high value. This requires a significant downards adjustment for the 1 year old home vs. the new home. This is because the builder hides significant concessions in the new home price that cannot be replicated in a resale. This is very apparent in paired sales which creates an economic obsolescence of as much as 10% in an existing home vs. a new home.

Roger: Your statement is in complete contradiction to my observations of MY local market...

Although there is some observed softening and greater willingness of homebuilders to concede little things without markeup... and I am talking paint colors or other builder cost non-issues.... the historical and apparently continueing trend is instead for most homes with established landscaping, little nicetites like installed towel racks, tasteful interior decor (Wallpaper borders etc), and (occasional biggie) drapes, to sell for as much as or occasionally more than those brand spanking new or under construction properties (even those which due to stage of completion offer options for personalization of finishes) !!!

So here again it is a case of KNOW THY MARKET!!!

This 'cost approach' debate runs continious, and probably always will :roll:

I also take issue with Mike "cost approach more applicable in unusual properties" as one had best 'extract from the market any functional superadequacy issues".... or to put it another way, what would uncle Bob pay for the thing even IF it has gold plated heated toilet seats :lol: .

Shoot Mike, Substitution IS market, taint Cost from a book it's derived frum Da Market!!!...

Still, like Austin, I find the cost approach to be a good check on the market. If I find something wildly off from 'typical area figures' I am going to take a real close look as to why!

It is another string to the bow, folks, not saying you have to play it, just know it's there and gain the skill to use it when it is applicable!