Is The Cost Approach A Real Thing?

[NC Appraising]

The 30-second CA process that a lot of appraisers use should never be assumed to be well refined.

- Land value by I-backed-into-it (sales comparison conclusion - depreciated costs = site value) is meaningless all by itself. And virtually always wrong when compared to actual site values.
- the bundled cost/sf figure in most cost services is an aggregate that includes multiple elements, all of which can vary somewhat from the base descriptions
- Fees/permit costs vary by jurisdiction. As an example, there are 88 municipalities in Los Angeles County alone and all of them have a different combination of fees and permit costs.
- costs and profit margins vary according to property type and market demand in that market segment.

If an appraiser would spend as much time actively developing a Cost Approach as they spend on their Sales Comparison the CA outcomes would often - maybe always - end up looking a lot different than the 30-second CA cartoon that normally gets used in the 1004.

I disagree...

If the cost approach is so inaccurate why does the cost approach almost match the sales approach in almost every appraisal that I see. Must be pretty accurate to me. LOL


Joking aside
- Land value by I-backed-into-it (sales comparison conclusion - depreciated costs = site value) is meaningless all by itself. And virtually always wrong when compared to actual site values.


100% agree. But, I like deriving a % of the extraction method as compared to actual good site sales. I can then apply that % to the extraction when site sales are none existent.

 

[Elliott]

Bard (Gemini) says:

"Q: Didn't FNMA consider not using the Cost Approach on the 1004 Form?

A: You're right, there have been discussions about potentially removing the Cost Approach from the Fannie Mae 1004 Form. However, as of February 24, 2024, it is still included and required for certain types of appraisals.
Here's some background on the discussion:

• Concerns: Some argue that the Cost Approach can be less reliable than other methods due to the challenges in accurately estimating depreciation and construction costs, especially for older properties or in volatile markets. They also suggest it adds unnecessary complexity and time to the appraisal process.
• Benefits: Others argue that the Cost Approach provides valuable information for unique properties, new construction, and understanding the intrinsic value of a property. It can also be helpful as a check on the other valuation methods.
• Current Status: Fannie Mae has not made any definitive decisions about removing the Cost Approach from the 1004 Form. They are likely considering the various perspectives and conducting research before making any changes.

So, while there have been discussions, the Cost Approach remains a required part of the 1004 Form for now. It's important to stay updated on any future developments from Fannie Mae regarding potential changes to the appraisal form and requirements."

 

[Ariba]

Which cost approach are we referring to – the cost to replace or replicate with a similar property? The consideration is, how much would it take to construct an identical or substantially similar property in terms of size, quality, and utility, taking into account current construction costs and materials? It's crucial to note that not all cost approaches are created equal.

For instance, factors such as Specialized Trades, Historical Materials, Craftsmanship and Techniques, and Building Code Compliance play a significant role. Determining the property's depreciation, navigating material and labor costs, and understanding the impact of these variables on the property's cost approach requires expertise beyond the appraiser's scope.

The process of extracting or backing into a land value may seem questionable. While the cost approach can be valid for new construction, skepticism arises when dealing with existing properties. The intricacies involved in accurately assessing and adjusting for these factors highlight the challenges and limitations of relying solely on the cost approach.

 

[Tom D]

unless you really do it correctly, not likely, why put your foot in that bear trap for the board to chop it off.

from the appraisal institute scope of work book.
The cost & income approaches to value were not necessary for credible results in this assignment and were not performed.

 

[sputnam]

The Cost Approach is as reliable and as useful as an appraiser makes it. Many appraisers don't bother to actually analyze data to arrive at the subject's land value. Many dont' have much of a clue how to actually use Marshal & Swift (or whichever cost service). Psst... read the instructions. I can't prove it, but I certain that most have never talked to a local builder about building costs... but, of course, their report says they did. I've seen reports that cite 'Appraiser Experience' as support for both the land value and as the source for building cost data. Are these the same appraisers who complain about the lack of public trust in the appraisal profession? Learn the craft and do the work.

 

[Tom D]

i have a FHA approved cost estimator who does a very detailed segregated cost breakdown. amazingly, he is more accurate that a lot of contractors. for a 1700 sf GLA rehab he charges about $900.
now maybe some of you experts should present yourself as doing that. i do rehabs and help with lender financing. i know all about cost, but around this big, very old city, depreciation and land cost will put a steak right thru your license, perhaps.
me poor big privileged urban appraiser, cost approach rarely seen in my reports. why put my foot in that bear trap.

 

[JamesDPratt]

Yes, the Lender will require in most cases two items
1 - Site Values
2 - Remaining Economic Life

I use Alamode and have the Remaining Economic Life worked out in the reports internal spreadsheet
I can modify it, but for 95% of the homes I don't even look at it

I also have two ways for get Land or Site Value built into my Master Spreadsheet
After it reaches a Site value it also provided adjustments for Garages Slots, Pools, Shops, Solar, Site Site
and
provided neighborhood and comparable charts and graphs for my reports

James Pratt
Redding, Ca

look me up and I will help you with your extended training

James

 

[Terrel L. Shields]

due to the challenges in accurately estimating depreciation and construction costs, especially for older properties

In fact, if you use old comps with old houses, it is relatively easy to determine the accrued depreciation. To differentiate the external from functional from physical...well, that's more difficult. But USPAP only requires you to address the accrued total depreciation. When applying REPLACEMENT (not REPRODUCTION) costs, and estimating the land value, you know the accrued depreciation regardless age. If your comps have land value plus a contribution for the improvements, then we can calculate the depreciation. And with an estimate of total life - we can calculate the effective age. The fact we could be wrong about the total life is meaningless. It is the consistency between your estimate and subject that matters. 40% is 40% BUT you need to apply the TEL etc. for each comp the same. So say my subject is 70 years old and has been updated 3 times. It sells for $200,000 and locally lots of similar size sell for $50,000. The contributory value of the improvements is $150,000. If a new house in the area is selling for $300,000 on the same $50,000 lot, then the $100,000 difference represents the accrued depreciation. And you can do that for the comps and if your house is similar age, then you can bet the same percent applies in the CA and then almost certainly, the results of the CA and the SA will be similar.
There are difficult areas to determine the land value. There are areas where land is in transition, which we cannot any longer call "gentrification"... There are exceptions but by in large, the CA works. All three approaches relied upon MARKET DATA. None are created in a vacuum.

a steak right thru your license

T bone or ribeye?

 

[John Hassler]

The two easiest time to extract land value from a sale is when the improvements have 0% depreciation or 100% depreciation.

To the OP, if your market is built out it typically means it’s an older market. Most likely market tastes have changed. Look for heavily depreciated homes, the smaller the better, but even homes in good condition will get sold for land value in certain markets (very common in Los Angeles where there are older SFRs on multi-family sites).

Once you get a feel for completing the cost approach you can really hone your skill by completing it before the SCA and avoiding the anchoring bias it causes.

 

[Elliott]

The problem with the CA for residential is, as Occam's razor would indicate, most of the information is developed from the SCA and the CA involves a number of steps which all have a plus or minus amounts, or just 'estimates.' And its reliability isn't improved when there is scant market data.