Is The Cost Approach Flawed?

[Have Laser-Will Travel]

It's all about correctly adjusting for the factors that affect it. As you mentioned, depreciation, including adjusting for various obsolescence...the end result will go hand in hand with the sales comparison approach. If not, then one (or maybe both) approaches were adjusted incorrectly.

Do you feel the cost approach is reliable on its own?

 

[Have Laser-Will Travel]

Why is it any less accurate than adjusting for condition in the sales comparison approach?


No


Yes

I suppose.

 

[Have Laser-Will Travel]

It would be the appraiser who derived the depreciation saying that

Depreciation is supposed to be market based, not taken blindly from some manual. Unfortunately, there are some who simply flip through pages in manuals or click through online entries without any actual market testing of the resulting data.

As for the title of the OP, it is not the cost approach itself that is flawed, but the application of the cost approach is, in my experience, sometimes flawed.

Some say it is a very misunderstood approach.

 

[Have Laser-Will Travel]

Flawed? Ya Think? The CA is all that and a box of cracker jacks. I like to call it the "Summation Approach" since it involves so many intermediate conclusions. Best to wear a wizards robe when its being prepared. Statically it will be occasionally correct.

One problem I saw was construction costs varying widely.

 

[Have Laser-Will Travel]

Deriving adjustments using the cost approach is a lot more supportable than the supposed millions of matched pairs that people magically discover..............that never existed.

Hmmm, I've found paired sales to fairly consistent but, maybe I had a tendency to stop analyzing once the adjustment value got be where I thought it should be.

 

[Have Laser-Will Travel]

Market extracted depreciation is accurate. USPAP doesn't require you to address EP, Functional, External obsolescence, only accrued. Epeley's work describes the technique.

I need to look at that.

 

[Have Laser-Will Travel]

I'm sure this will come as no surprise to most....
Yes I believe it is flawed as I believe most if not all of RESIDENTIAL appraising has some type of flaw. Minor, major....
Why else is appraising considered an ART and not a SCIENCE????

If I remember correctly, I seem to recall hearing a rumor/gossip that the powers that be were considering eliminating the CA section on the updated 1004 form back in 2005...

On a typical RESIDENTIAL appraisal (although it is quite apparent from GH's poll, there is no such thing as typical), what does the CA really add to the Sales Comparison Approach???

It seems to often used to support the SA and vice versa. Alone, I wonder how many would pick it over the CA?

 

[DWiley]

If it is "market-based" then it is not depreciation per se, it is buyer reaction to that depreciation. Dividing the effective age by the total economic life doesn't consider the market. It is only accounting for a change in the physical elements of the improvements. There's nothing to say that buyers react to that depreciation on a dollar-for-dollar basis.

Your post actually illustrates my point Of it is done correctly dividing the effective age by TEL absolutely does consider the market. Done correctly it is directly based on the market

Appraisers are taught in beginning courses how to extract total economic life and effective ages from actual market data Those are NOT supposed to be numbers just taken fromm a manual or web site. If those numbers are derived correctly then the depreciation IS market based. Yet one could search the archives of this forum and find countless post indicating the poster does not know how to extract those numbers from the market.

 

[hastalavista]

If it is "market-based" then it is not depreciation per se, it is buyer reaction to that depreciation. Dividing the effective age by the total economic life doesn't consider the market. It is only accounting for a change in the physical elements of the improvements. There's nothing to say that buyers react to that depreciation on a dollar-for-dollar basis.

In the sales comparison approach, the market does react to an improvement's depreciation.
We usually adjust for that in age, condition, or functional inadequacies.

In the cost approach, we deal with Economic Life, Remaining Economic Life, and Total Economic Life.
While depreciation (a loss in value) is broken down into three categories that are applicable to the improvements (physical deterioration, external obsolescence, and functional obsolescence), those adjustments, along with the site value, equate to the same adjustments we are applying in the SCA.

The Cost Approach to value is simple to express:
Market Value = Cost - Depreciation

I occasionally do the cost approach before I do the sales comparison approach.
Unless the subject is suffering from some form of functional obsolescence which is exposed by comparing direct sales, you might be surprised at how often the indicated value by Cost Approach falls within the adjusted range of the comparables.
However, since I don't run multiple cost approaches with different costing sources on the same assignment (as a rule... I have before to test the different cost-source quality), I don't have multiple value indicators to reconcile within that approach.

When the cost approach is off from the sales comparison approach (like, outside of the adjusted and unadjusted range), it is usually due to a quality-of-data issue. I subscribe to Marshall & Swift; a recognized and reputable source for costs to use for our work. Sometimes their latest data (regularly updated) is imperfect for the specifics of my particular market or improvement.
Or, as Terrel has pointed out, it can be informative of an overheated market.
I'm seeing that right now in parts of Silicon Valley: The major Tech Giants (Google, Microsoft, Facebook) are growing significantly and their workforce, looking for housing close to their campuses, are driving up prices significantly.
Labor isn't going up that fast, materials isn't going up that fast, and land isn't going up that fast (although the national disasters and more proximate fires in Northern California are influences that affect material and labor costs... faster than the costing data can account for it). The market is hot. :The Cost Approach won't capture this rapid appreciation. There will be a difference in cost vs. sale indicators. The difference isn't attributable to EI: the incentive to build is somewhere between 10% to 20%, depending on the type of improvement and market that it is in. But the profits, right now, far exceed that.
This is meaningful information to the appraiser and to their client if the purpose is for mortgage lending.
This difference is commented and explained in the reconciliation of the approaches.

 

[ucbruin]

Because of the limitations of appraisal guidelines...
I still don't quite understand how the CA as an indicator of an over-heating market, adds to/aides the SCA and the appraised value...
In regards to RESIDENTIAL appraising the SCA is typically, if not always, given most consideration....
I'd hate to be the appraiser who has 3 model match sales that indicate $300,000....
But provides an appraised value under $300,000 because the CA indicated an over-heated market....

Or am I misunderstand TS' and DD's post regarding how the CA adds to the SCA...

As an aside...
As a staff appraiser for SPNB and BofA in the late 1987 to 1999, the appraisal department made it a point to instruct appraisers to employ some type of language, in the cost approach, that the user should not use the cost approach in the report for insurance purposes. I think this was because the bank didn't want the borrower to use our reports to under or over insure their homes, based on our slapped together CA. Neither bank gave a crap about the CA....