Interesting personal thinking from an insider...

[George Hatch]

I gotta go with Austin's sentiment that you cannot rely solely on any published cost guide (or income-oriented investment surveys) without calibrating the results for the local market and for the subject improvements quality. The training manual for the course clearly states that the while building type and type of construction categorizations can be classified as objective determinations, quality of construction is always a subjective determination. Reasonable persons will disagree sometimes on the specifics of quality gradation. The quality categories that M&S uses are deliberately general and are not intended to be absolutely specific for each property. Some adjustment of the costs using quality determinations has always been necessary, even if it is to split the difference between two categories.

Personally, I use construction cost breakdowns for the construction deals I appraise to cross check and verify against the M&S costs. Excluding those cost breakdowns with obvious fluff in them, I have found that the M&S costs are very reasonable most of the time, so long as I am realistic about the quality rating(s) used. Obviously, I'm not going to sit here and tell anyone that I would consider Cost to be a primary indicator for any but the most uncommon of situations (we're talking aabout a complete lack of other relevant data), but it has its uses.

I find the argument that since appraisers are not trained construction estimators then that justfies the elimination of the Cost Approach from those methods suitable for use in appraising. Granted, we are not specifically trained to cost out the exact quantity of materials for each property we appraise. But do we really need that kind of precision? After all, we are not bidding for the construction contract. Cost overruns do not come out of our pocket. We are simply appraising the property as a whole. Within this context, the use of the Cost Approach, specifically the Square foot method, which is the most commonly used method for appraising, is perfectly suitable for the job at hand. Competence within the scope of our assignment is not only possible, it is readily achievable simply by following the directions.

In my experience teaching the course, the people who pooh-pooh the Cost Approach the most are the same people who refuse to learn how to do it properly.

True enough, the Sales Comparison Approach is king when it comes to most kinds of properties. Good thing, too, because some appraisers are incompetent to do anything more. However, that does not change the fact that there is more than one valid approach to value, and that reasonable Cost Approach analyses are within everyone's reach.


George Hatch

 

[Mike Garrett RAA]

By using the term "unique" I mean there probably are not any suitable comparables. Ever have a property where the only way to estimate the value is by the cost approach? It happens....infrequently, but it happens.

I use the book Fundamentals of Real Estate Appraisal as a reference for my registered appraisers class. It address the cost approach in great detail. Once of the questions on the state exam for new appraisers also asks that queston....When does the cost approach best apply? The correct answer is "special purpose buildings". The illustration in the book is that of a church.

Lets put this to bed once and for all. I am an advocate of considering all approaches to value and then selecting those that are necessary for me to produce a creditable appraisal. I like to develop the cost approach in order to determine the land value and account for depreciation from all causes. Additionally, I will develop the income approach for those residential properties that are income producing.

 

[Ben Vukicevich SRA]

George,

In my experience teaching the course, the people who pooh-pooh the Cost Approach the most are the same people who refuse to learn how to do it properly.

There is some truth in your statement. And believe me, I know how to do it properly as a former licensed builder in NJ. I pooh-pooh the Cost Aproach because to do it properly and expertly, you really need a local builder's breakdown. If anyone remembers doing a demo report for the old SREA, you HAD to use a builder's breakdown for Cost New with Marshall Swift as a check. That's been around since the 1970's, prior to USPAP and Competency. The local contractor is the recognized expert at Cost New, not the appraiser, not the cost book. You used his figures for the Cost New and the appraiser worked the voodoo magic of depreciation after that-which is altogether another subject as the voodoo depreciation method is most often NOT market abstracted but an age/life method which has nothing to do with the market as it is just another accounting procedure. Next quest, try to get any two or three local contractors to be close bidding on the same project. :lol: :lol: So we're using lots of stuff in an approach to value that has nothing to do with the market and then calling it an indication of the subject's market value???? Wow. And dumb.

I really find it amusing that most appraisers will not quote a repair cost in an appraisal because they are not an expert... or a licensed electrican, licensed HVAC guy or licensed plumber. They acknowledge the value of an expert in certain circumstances, but then they will go full steam ahead and blindly complete a Cost Approach with no problems and totally ignore the Competency provision in USPAP.... :lol: :lol: A little light bulb needs to go on in lots of appraisers heads so they can see where they're heading---USPAP hell.

Does the Cost Approach really provide an indication of the Market Value of the subject's fee simple property rights or is it just a summation of the costs of the real estate present or to be present on the site less depreciation derived by a non-market derived accounting method? It's basically akin to an accounting procedure. It's a summation. There is no guarantee that anyone will pay the amount of the final cost estimate in exchange for the rights to a parcel of real estate.

Finally, is it not misleading to use a methodology that is almost NEVER used by typical market participants?

And if you do have a special purpose property to appraise, don't you think the appraiser (not being qualified) should have an expert cost out the project? If that is true, then it holds true in all cases, the appraiser is definitely not the expert at Cost New and is not competent to complete a Cost Approach on his/her own without expert assistance.

Personally, I find that people who tout the Cost Approach haven't a clue as to what's needed to complete it properly/expertly 8O 8O A true test of the applicability of the cost approach would be to have a sample property posted on the forum and then have everyone cost it out new using Marshall Swift. Let's forget depreciation. Just cost new. I'd love to see the "expert" results on that one.

Damn, I better renew my builder's license this year so when I go before the state board on a Cost Approach, I'm a recognized expert who's cost new opinion can't be tarnished. The rest of you....oh well.

Hey, maybe I'll scan and post the Cost Approach from my old demo report someday..it's a trip...and an excercise in futility

Ben

 

[Austin]

Ben:
You make some good points but I still say that the science of real estate appraisal is based on the principle of substitution and the appraisal science has no meaning without a point of reference. The economic pecking order of the real estate market uses a point of reference called the depreciated replacement costs. Depreciation is defined as the discount offered to entice the buyer to buy an existing dwelling instead of purchasing a new one. What rational person would not prefer a new home to a used home? Every property has to be somewhere in the pecking order to maintain order because maintaining pecking order defines market stability which is the objective of our profession.
For example: Today I did an appraisal in the most exclusive resident subdivision in the area. The comps & subject property ages ranged from 8 to 40 years for very similar styled houses in the same neighborhood. I made one small size adjustment and the comps were adjusted. Age was meaningless. The subject property was purchased in 1999 for $230,000 and is presently under contract at $215,000 and the data indicated a price of $241,000. The pecking order in that market segment is all screwed up. How do you appraise under these conditions? If big ones sell for less than small ones and old ones sell for the same as new ones there is no order and somebody is getting screwed.
Every science has to have a point of reference because science is the study of relationships and correlating value factors. Everything is defined by its relationship to the pecking order and the pecking order must have a point of reference and generally does. I have a database of 2,000 residential sales. If you could see the graph of the raw data with GLA graphed against sale price you could see that the pecking order in the market is generally intact with the exception of the upper end market that is totally screwed up. Why is this market segment screwed up? Because most of the appraisers that work in that market are number hitters because the people that buy and sell these homes demand number hitters. Number hitting results in a distorted pecking order and no market stability which defeats the purpose of our professional existence.

 

[Ben Vukicevich SRA]

Austin,

The principle of substitution states that if two items of equal quality exist, then the item with the lower price will gain the widest distribution...but it's based on the premise that both items EXIST now..so if you're in the most exclusive residential subdivision in the area as you stated...they may have or had no substitute choice when they buy now or bought then..thus your screwed up market. Location/scarcity then rules and the principle of substitution goes out the door along with the buyers rationality....they want that area/neighborhood and that's it. No logic to it. No substitute available? Then, I have to take "this" one and "this" one may not be a good comp for you to analyze.

Time to lose the science part of appraising and move to the art side...check the available listings to see how tight the market is...call the brokers and find out the motivation behind the sales you analyzed. If you believe strongly in the Principle of Substitution, try to find out if you can eliminate comparables from the report and your database that had no substitute choice for a buyer in that neighborhood when they sold-they would skew your value range upward, would they not? But you know all that stuff because you've been around as long or longer than me. And if they all check-out OK, maybe it's worth the $241,000 and your seller is getting screwed..not the past buyers in the development???? What would you have appraised it for on a refi not knowing the sale price????? If you're comfortable with the $241, then $241 it is.

Forget the depreciated replacement costs...and act like an buyer. The typical home buyer only cares about the asking price of House A to the asking price of House B, plus the contributing value, if any, between the differences in each home that they perceive to have value. And to complicate matters, those differences are valued by each buyer in subjective amounts that they assign to each perceived difference and probably another good reason why we shouldn't make any adjustments at all 8O 8O in the Sales Comparison Analysis. Lord, I loved those old FHA <=> forms....you acted like a buyer not an appraiser..After all, those adjustments we make in the Sales Comparison analysis are just a feeble attempt to refine a value range set by the comparable sales :lol: :lol:

Ben (The "art" appraiser guy)

 

[Terrel L. Shields]

This is why I try not to use the labels "Complete" and "Limited".

Insensible remark. Failure to disclose a report is limited is a violation of USPAP. Any unlabeled report must be assumed to be self-contained and complete.

Complete does not mean all three approaches must be done. Limited does not mean an approach is left out. In court, you best have all three, as your competition will if they have halfa brain. (see the court case book that the App. Found puts out)

Functional obsolescence is as easy to calculate as wear and tear in older house.

develop the cost approach in order to determine the land value

One of first functions. How do you make a land adjustment if you have not figured the land value of all the comps and the subject? Unless you are lucky enough for all three to be in the same subdivision and same size, land adjustment is the most locked in verifiable adjustment you can make.

The example of a Church may be applicable for as a case for the Cost App. but that approach is useful for making adjustments that cannot otherwise be extracted from the marketplace.

Sample. Subject is 10 yr old, w/ 6,000 Sf 1 year old shop building for car hobby owner. Comps? 10 yr old home with 5 year old 3,200 SF det metal steel truss garage, insulated, etc. 10 yr old home with new 1,200 SF frame shed for RV. 10 year old home with 10 year old 4,500 SF horse barn......you are given the exact cost of all 4 at the time of their construction...any you cannot make an adjustment??? Do you have a choice? Isn't calculating some per Sf adjust for each which might be $4, $12, and $9 abstracted, tells you squat? In my area this scenario plays out all the time. Using some part of the Cost App to analyze comps is a necessary part of the story.

Ter

 

[Fred]

Mike,
I wonder why someone would think that the special purpose properties (I usually call them special use) require the cost approach. While I would probably give that answer on a licensing test, I would never use the cost approach in real life to estimate the market value of a special purpose property.

I think it is fair to say, as the 7th circuit court once did, that the cost approach "is generally the least reliable method." This view is held across the spectrum from the cost approachs strongest advocates to those (like me) who do not regard it as an approach to market value at all. Although, I would depart from Ben and say that appraisers can estimate cost new with the same accuracy they estimate value (and with the backing-in aspect of depreciation, if the cost is over-estimated, it just gets sliced off as depreciation).

There are some tough, but fair, question on using cost for special use properties, that don't seem to have good answer -
The cost approach would suffer from the lack of comps at least as much as any other method. So if it the generally least-reliable method is made worse by no comps to support depreciation, why would such an appraisal be credible (as they say in USPAP)?
Just because it is not readily apparent how to apply other methods, does this in anyway elevate a no-comp cost approach to a reasonable level of acceptability or reliability?
Is it rational to use production cost as a standard of value for a property no one would one would produce; replacement for a property no one would replace?

The AI text and its clones are not the only school of thought. Among other noted texts I have is one that says of special use properties, “…in no sense can the product of this model [cost-less-depreciation] be market value though the label is often used.”

 

[Ben Vukicevich SRA]

Among other noted texts I have is one that says of special use properties, “…in no sense can the product of this model [cost-less-depreciation] be market value though the label is often used.”

Exactly correct...Our job is to determine the market value of intangible property rights, so why do we still feel this need to add up the value of tangible items and depreciate them, then try to call it an indicator of market value???? So the Cost Approach does not indicate fee simple market value.

Ben

 

[Terrel L. Shields]

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

I'm wit you Lee Ann...in my market builders are selling for 8% profit, when the costs rise enough the margin falls to 6%, they raise the price. Most are sold before completed, w/ buyer picking color and carpet. First resale? Likely 30-60 day to close, maybe only 7 day til first offer, and will sell for last years cost plus realtor commission (6-7%) It will trail new house cost by very little. Land, in particular, is raising builders cost. Subdivisions here that were built on $4000/ac farmland 4 years ago are being built on $11,000/ac land now. The cities are strapped to keep up with the utilities and Bentonville recently passed $3600 impact fee. Fayetteville and elsewhere soon to follow.

As for Cost app....farm buyers apply that method more than comparing sales...w/limited avail. properties they analyze the dwelling and the barns...maybe something like...Gee, these chicken houses are 20 yr old and need update. I will have to spend $25,000 to upgrade to tunnel vent. and these houses are at least half gone..new equip. will be $10,000. I can build a new one for $150,000, SO I can give $75,000 plus 35,000 or $110,000 for old one updated or $150,000 for new...and I could be raising birds with 30 days in existing one, more like 120 days for new const. assuming I can get a crew soon. That's 2 batches I miss waiting to get built when I could be turning $20,000 a batch. Land is $2000/ac. so that is $80,000 and that house is 2,000 SF, surely not worth more than $30/Sf..then they total...Buyers do use the Cost approach, just not in the formal way we do, and aren't we supposed to replicate the market?

I have always thought that valuing a church, museum, etc. is an utter waste of time. An engineer or Architect's estimate of cost would be just as applicable and useful.

 

[Carnivore]

This is why I try not to use the labels "Complete" and "Limited".

Insensible remark. Failure to disclose a report is limited is a violation of USPAP. Any unlabeled report must be assumed to be self-contained and complete.

Terrel,

I knew this e-mail would generate some tremendous discussion and even some healthy debate. I did not edit the e-mail and the statement above is taken out of context. Sorry, you were not privy to previous e-mails. I should have deleted that portion. The comment about the importance of scope was really the point. Again sorry. But, as the statement stands you are absolutely correct. Also, the man who wrote this is considered a USPAP Geek. And for the benefit of the very young appraisers here in more comtemporary terms he is "so gay in USPAP"