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Is Cost Approach For Rowhouse Misleading?

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Ariba

Senior Member
Joined
Feb 8, 2004
Professional Status
Certified Residential Appraiser
State
Colorado
As we all know the cost approach is a real estate valuation method that surmises the price a buyer should pay for a piece of property and should equal the cost to build an equivalent building. In the cost approach the market price for the property is equal to the cost of land plus cost of construction, less depreciation.

Having said that, how would you determine the land value of a Rowhouse with a parcel site of 350 SqFt? I know, subtract the cost of constructing the building, minus depreciation and you have the cost of the land. However, how feasible is it to buy a 350 SqFt lot in the middle of the city? Furthermore, how to you ascertain a value to the amenities of the complex. Is it cost approach reasonable, physically possible, and/or financially feasible or is the approach misleading for Rowhouses and Townhouses?
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
Having said that, how would you determine the land value of a Rowhouse with a parcel site of 350 SqFt?
There are any number of ways to value land as if vacant. Get a text book and go down the list. What does a 3,500 SF lot cost? Divide by 10. That's the first thing I start with. Doesn't your MLS have a separate search for land? What is the assessors land to value ratio for other houses? What would a tear down cost?
However, how feasible is it to buy a 350 SqFt lot in the middle of the city?
You pretend that a subject is going to sell in the sales approach don't you? Pretend you can buy land. "Feasible" does not mean land is available. The CA is asking you to value the land under the subject. Obviously it is not vacant...but you value "it as if vacant and available for its highest and best use" - quote unquote from the textbooks. That is the first step in the Appraisal process ALWAYS. Cannot determine HBU without it. If you don't know what the bare land is worth how can you determine if the improvements add value to the property or not?
Is it cost approach reasonable, physically possible, and/or financially feasible or is the approach misleading for Rowhouses and Townhouses?
You are suggesting that HBU is impossible to determine? Land value is what the bare site would bring. Some situations are not easy to estimate. That relates to the reliability of the data, not the reliability of the approach. Do you think if the row house was torn down that the 350 SF could not be sold? That is your problem. Value the land...by the foot, the front-foot, or unit. There is more than one way to skin a cat without getting hair in your teeth. Likewise, the REPLACEMENT cost should be relatively easy to determine. Row houses are still built, infrequent or not. They still can be calculated. And sales or income methods will determine the impact of depreciation.
 

Ariba

Senior Member
Joined
Feb 8, 2004
Professional Status
Certified Residential Appraiser
State
Colorado
I said 350 SqFt lot not 3,500 SqFt.
Is buying a 350 SqFt lot feasible in the middle of a city?
I am not pretending anything, the subject sold.
I did not say that the HBU could not be determined.

Also, in my experience Rowhouses/Townhouses are not built as individual units.

Don't get me started on the income approach!
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
Is buying a 350 SqFt lot feasible in the middle of a city?
Why not? And read my post carefully. If a 3,500 Sf lot has sold, it gives me a base price when divided by 10... If residential land is selling for $10 a SF, apply that. Then see what the assessor calls it. Then see what the assessors land to value ratios are. There are more ways to value land than finding a duplicate lot in the same area.

It does not matter if no land is currently available. the CA relies upon you valuing the LAND under your property. Sales are simply a proxy for your site. The LAND value does not disappear once a building is built. It is what transfers, not the building. When you sell a house, the legal describes the LAND and the rights that go with it are what transfers. "Feasible" is not an issue with the LAND. Again, I can bet some property has sold nearby...a tear down perhaps, or perhaps the last 350 SF lot sold was in 1939. It still sold. The CA is almost always applicable...necessary, perhaps not. I never recall a time that doing the CA was "misleading" but it often may be the weak sister in the report and given little or no weight. That is a function of the quality of the data as I said, not the approach. And what town in Colorado are we talking about?
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
As we all know the cost approach is a real estate valuation method that surmises the price a buyer should pay for a piece of property and should equal the cost to build an equivalent building. In the cost approach the market price for the property is equal to the cost of land plus cost of construction, less depreciation.

Having said that, how would you determine the land value of a Rowhouse with a parcel site of 350 SqFt? I know, subtract the cost of constructing the building, minus depreciation and you have the cost of the land. However, how feasible is it to buy a 350 SqFt lot in the middle of the city? Furthermore, how to you ascertain a value to the amenities of the complex. Is it cost approach reasonable, physically possible, and/or financially feasible or is the approach misleading for Rowhouses and Townhouses?


IMO, Great questions.

First, the Cost Approach is never misleading as long as (a) it is done correctly and (b) the appraiser appropriately discusses its strengths/weaknesses in the reconciliation, and gives it the appropriate consideration (which may be zero) in the final value reconciliation.

Second, I would argue that the rights associated with the common area amenities are inherent within the value of the site. In order to get the amenities in the complex, one must own the site. Access to those amenities exist regardless if the site is improved or not, so they are not (IMO) attributable to the improvements but rather attributable to the land.

...how would you determine the land value of a Rowhouse with a parcel site of 350 SqFt? I know, subtract the cost of constructing the building, minus depreciation and you have the cost of the land.
I appreciate the rhetorical nature of the question. You've described how to identify the site value for this problem (make sure you include that the site value includes the tangible benefits of the common areas, etc.).

However, how feasible is it to buy a 350 SqFt lot in the middle of the city?
This is addressed in the strenghts/weaknesses of the approach (and of the data).

The usefulness of the cost approach is not limited to concluding a value indication; although that is what we typically employ it for.
I think it is fair to say that most appraisers would conclude the CA on what you describe is not necessary or meaningful for credible results and wouldn't include it (I wouldn't, if it were up to me).
But, if the client requires this approach to value and you accept the assignment, then it becomes an assignment condition which must be completed.

You've outlined some key weaknesses of the cost approach for this specific valuation problem. Those weaknesses don't eliminate the ability to complete the CA: you've stated the basic formula-

Value = Cost - Depreciation
But you've equally outlined the reasons why the approach should not be considered as reliable as your other approach(es); in fact, the weaknesses of CA may be so great that you determine it is given no consideration (it is not reliable) and put 100% consideration on the other approaches used.

The idea of an analysis being misleading if it is completed in an appraisal is a misnomer (but a common one).
The appraiser is ultimately responsible for determining what data, analysis, methods, and conclusions should be considered to conclude credible assignment results. The inclusion of a methodology (or even data) that would render results less credible is not "misleading" as long as the appraiser communicates to the client/intended users why that analysis/data isn't considered useful, necessary, or reliable.
I want to re-state that because I think it is significantly misunderstood by some (not you, but there are a number of other threads recently which equate assignment-conditions with somehow returning unreliable or misleading results):
  • A client can ask for an approach to value to be included in an appraisal report.
  • It is up to the appraiser to determine how that approach is considered in the appraisal's analysis and value reconciliation.
  • Including an analysis (or data) which the appraiser does not consider "reliable" does not constitute a misleading report as long as the appraiser identifies the weaknesses of that data/analysis and states how they were considered (in this case, probably not considered at all).
  • What would be misleading is if the appraiser included the analysis or data, and then gave it consideration it didn't warrant which resulted in the conclusions being non-credible.
  • In your case, if the client told you that you should include the cost approach and give it equal consideration as the sales comparison approach, that would be an unacceptable assignment-condition assuming you conclude that the CA isn't reliable enough to be considered equally (appraiser judgment is key here)
  • However, no one is mislead if the client asks for an approach, the report includes that approach (done correctly), and then the report discusses its weaknesses and concludes it is not reliable to consider in the final value reconciliation.

That's my 2-cents.

Good luck!
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
Here's an example of including data in a report which isn't reliable; I do it a lot.

I'm looking at a sale that, on paper, seems to be a great comparable to include in my sales comparison approach. However, after doing researching and verifying/confirming the conditions of the transaction, I discover certain things that I conclude make it a poor comparable.
I will typically narrate that data point in my report (include it in the report); discuss why it appears to be a good comparable at first glance, and then discuss what the additional research discovered about the sale. I'll conclude that because of what I've discovered, I do not consider it a reliable comparable and have therefore not included it in my sales grid.

What I did with the data point I can do the same with the cost approach.

Including this data is not misleading; I've discussed and supported why it isn't a comparable to consider in the valuation. Same concept with the cost approach. :cool:
 

J Grant

Elite Member
Joined
Dec 9, 2003
Professional Status
Certified Residential Appraiser
State
Florida
The cost approach on URAR form says "opinion of site VALUE" (not the cost of site)

Just because this approach has the word "cost" in the title, it is still a value approach (not solely a mathematical adding and subtracting of costs )

This applies more to certain aspects such as the site. While land sales are an indicator of what land costs to buy, such as broken down per sf, land sales might be poor indicators for the value estimate of a site in the cost approach, especially for as you see in this example a PUD with small lot sizes, or villas or townhouses on very small lots. How can a tiny dinky lot be worth so much on the cost approach, yet a vacant site that sold a mile away be worth so much less $ per sf? Because as Denis said, the site has gained value by being inside a PUD or community, with use of the shared amenities and benefits, real or perceived, from living in the community.
 

Ariba

Senior Member
Joined
Feb 8, 2004
Professional Status
Certified Residential Appraiser
State
Colorado
"But, if the client requires this approach to value and you accept the assignment, then it becomes an assignment condition which must be completed."

I really take issue what this. Even if the conditions are USPAP vioiations and/or misleading? Clients/lenders on a regular basis request conditions that are USPAP violation or misleading that cannot be met. Like comparables with the same number of bedrooms and baths, 3 active listing from within the market area, comparables that sold in the last 30 days, remove picture, etc.. You get the picture. Do you now decline the assignment because the clients/lenders conditions cannot be met.

I usually explain the situation.

If you put a value on the property site and it is not feasible for the buyer to purchase a similar a site within the market area are you not misleading the client/lender. There have been no sales of 350 SqFt site in the entire metro area? I know you can make all kinds of assumptions and adjustments, larger parcel, different market, different zoning, etc. and come up with the value. That is misleading IMHO. Another issue I have with the cost approach is the value of money. Are the buyers really going to wait 16-months for the unit to be built? What about interest rate, etc.
 

J Grant

Elite Member
Joined
Dec 9, 2003
Professional Status
Certified Residential Appraiser
State
Florida
If you really feel assignment conditions are a USPAP violation, then decline the assignment.

But you are accepting the assignment, and still preparing, per your way of thinking a "misleading" cost approach. You don't seem to understand that a cost approach is still a VALUE approach, not raw cost added or subtracted in columns. The cost approach reconciles within its own development the contributory value of cost in the market . That is why ext market obs is factored in, or entrepreneurial incentive ..

As far as site, did you read/understand what Denis wrote? Or what I wrote about site location in a PUD/community with amenities ?

Another issue I have with the cost approach is the value of money. Are the buyers really going to wait 16-months for the unit to be built? What about interest rate, etc.

Answer these questions for yourself when doing the cost approach and that will be a guide to arrive at value. Why is that little 350 sf site worth so much? Because the buyer does not have to wait 16 months. Because a low interest rate is impacting prices. Because there are no vacant 350 sf sites available inside the community, and only way to get that site is buy it together with the row house, the value extracted out for site portion is the value for lot. Nothing in cost approach demands the site value be based on vacant site sales and imo doing so can lead to skewed lot values in some assignments..
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
"But, if the client requires this approach to value and you accept the assignment, then it becomes an assignment condition which must be completed."

I really take issue what this. Even if the conditions are USPAP vioiations and/or misleading? Clients/lenders on a regular basis request conditions that are USPAP violation or misleading that cannot be met. Like comparables with the same number of bedrooms and baths, 3 active listing from within the market area, comparables that sold in the last 30 days, remove picture, etc.. You get the picture. Do you now decline the assignment because the clients/lenders conditions cannot be met.

I spent a lot of time outlining why the cost approach, when not necessary or even reliable, can be completed in a USPAP-compliant manner. I guess I wasted my time (which happens).

And, yes, if a client has an assignment-condition that I cannot meet, I do decline the assignment. More likely, I call the client first and ask them, "Your engagement-agreement requires X; I don't think I can meet that requirement. Can you waive that? If not, I'll pass on the assignment." This recently happened when a potential client, in their engagement agreement, stated they require any conditions to be addressed within 24-hours. I said I couldn't accept the assignment under those conditions. They said, "don't worry about that then."

But, don't take my word for it:

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