Question regarding Cost Approach!

[Fred]

I think that many appraisers realize that the cost approach is being required by their clients in order to be used for insurance. There are a few clueless appraisers who don't realize this, but they are beyond help anyways. However, most appraisers keep on doing the cost approach even when it is of no use for valuation purposes because the cost approach is required by the client. In many cases, the choice is to do the cost approah or lose the client.

No use for market valuation purposes, but of use for insurable value purposes. I suppose it is out of the question to ask the client to indicate that they need cost for insurance (so-called identifying the intended use), and then leave out the irrelevant parts of the approach (so-called matching the scope of work to the intended use).

 

[Fred]

Mark, Santora has already stated What SS appears to be saying is that we just do not do the cost approach, and that we will then never need to worry ourselves with issues of functional obsolescence, external obsolescence, EI, physical depreciation, RCN, effective age REL,

It's funny. I never needed a translator before.

In this case, I suspect, the translator is deliberately exaggerating. It's a form of fallacious reasoning called a straw man argument. Since there is nothing wrong in what I did write. He'll make believe I wrote something else, something stupid, and argue against that. Personally, I think it is a form of masturbation.

 

[CANative]

Mr. Incognito,

Steven doesn't need me to rush to his defense so I'm just posting from my own point of view. I wish you would tone down your vitriole. It's distracting, it makes me wince and roll my eyes at your posts and, in my opinion, I don't think you really understand some of the points he has tried to make over the years.

I'm grateful to Santora for challenging me on the cost approach and forcing me to study it diligently.

 

[Fred]

Good morning all,

I am always looking for ways to improve, if you have a better way of determining EI then the market, please post it.

Mark,
I have no trouble finding EI in the market, when it is a market driven by EI. Say a guy buys a fixer-upper for $3, spends $1 in materials, labor and management, to produce a house worth $5. That's $1 incentive on a $4 investment or 25%.

If a person buying a house is an "entrepeneur" making an "incentive" driven economic decision, then why can't you simply pull the incentive out of the house prices.

 

[timd354]

No use for market valuation purposes, but of use for insurable value purposes. I suppose it is out of the question to ask the client to indicate that they need cost for insurance (so-called identifying the intended use), and then leave out the irrelevant parts of the approach (so-called matching the scope of work to the intended use).

It is not out of the question to ask the client to identify the reason that the cost approach is required and to fashion the scope of work to meet that purpose. The sad part is, however, that most lender clients are too stupid to even understand such a conversation or deal with a cost approach that is done in a manner that is different from the "typical" cost approach performed in most residential appraisals. Most people who order the appraisals at the lenders don't even know what the concepts intended use or scope of work mean.

I guarantee that if one did a cost approach with a stated intended use of determining insurance replacement cost and an appropriate scope of work for that intended use and left out the site value (which has nothing to with insurance replacement cost) and left out depreciation (which again has nothing to do with insurance replacement cost), the underwriter would stip for these items and would not be able to understand why they were not included.

Most of the blame for this problem goes to Fannie Mae....Fannie knows damned well what the lenders are using the cost approach for, and, yet designs their appraisal forms in such a way that everyone pretends that the cost approach is actually used for valuation purposes in most cases. Most lenders, just being blind sheep just follow whatever is on the Fannie forms without truly understanding or even caring about the actual concepts behind an appraisal.

 

[CANative]

Say a guy buys a fixer-upper for $3, spends $1 in materials, labor and management, to produce a house worth $5. That's $1 incentive on a $4 investment or 25%.

Is it a $1 incentive or a $1 profit? If he put the finished product on the market at $5 and it sold in a couple of hours to the first person who called would he think that his $1 EP was low and figure he could get $2 on the next one (EI)?

It may seem like a stupid question but I don't see how we can get a cost approach to yield current MV indicators unless we have a good sense of what entrepreneurs are thinking going into projects similar to the subject property. And entrepreneurs are probably at a loss when the market is moving in one direction or the other. And that's why I don't think the CA is a good methodology for residential property in anything but a stable market.

 

[Mark to market]

Mark,
I have no trouble finding EI in the market, when it is a market driven by EI. Say a guy buys a fixer-upper for $3, spends $1 in materials, labor and management, to produce a house worth $5. That's $1 incentive on a $4 investment or 25%.

And I would argue that this is random. Far better to have a 100 homes saying something then just one.

 

[incognito]

Greg, You seem to miss the point. Santora lurks, waiting to infect ANY cost approach discussion, and then adds NOTHING to the discussion, relevant to the discussion and original question. As usuall, this is the case here too. If you can demonstrate to me that her EVER addresses the original post with anything other than his condescending anti cost approach rhetoric, I will change my approach. I don't argue that he occasionally has something to say which can learned from, but good god, EVERY SINGLE TIME THE CA COMES UP, HE IS THERE WITH THE SAME OLD CRAP, OVER AND OVER AND OVER AND OVER... Lastly, don't underestimate my ability to understand his posts, over the years. He, if nothing else, has the ability to develop an almost cult like following. There are moderators here, 10,000+ posters hear, and many others who simply take what he says without question. Greg, I Hadn't had you categorized as one of the lemmings. I still din't think you are, but i think if you look at the facts, His is generally not a constructive addition to many threads...

Personally, I think it is a form of masturbation.

Santora, you need to meet a woman... Your mind (and hands) seem to be too focused on yourself!

 

[Mark to market]

It may seem like a stupid question but I don't see how we can get a cost approach to yield current MV indicators unless we have a good sense of what entrepreneurs are thinking going into projects similar to the subject property. And entrepreneurs are probably at a loss when the market is moving in one direction or the other. And that's why I don't think the CA is a good methodology for residential property in anything but a stable market.

Should one be putting down what the entrepreneurs are hoping for or what recent history suggests they will get? If it is market derived I should think it would be what recent history suggests they will get (maybe I should be calling it EP).

I must admit our market has been fairly stable here these past 4 months, perhaps that is the reason for things working out so well. I am hoping that now that I have established a good base I will be able to use the CA to measure declines or appreciation just thru entrepruneuial changes.

 

[Fred]

It is not out of the question to ask the client to identify the reason that the cost approach is required and to fashion the scope of work to meet that purpose. The sad part is, however, that most lender clients are too stupid to even understand such a conversation or deal with a cost approach that is done in a manner that is different from the "typical" cost approach performed in most residential appraisals.

I would argue that "not out of the question" doesn't come close. In my reading of USPAP, identifying the use of the analysis is required. It may be sad that clients have a limited understanding of this, but it is even sadder that their understanding got that way and does not improve because they are working with appraisers who want 'make them as instructed' to keep the client.

I think there are potential "problems" both in doing it right and doing it wrong. It's just a case of what you would prefer to be saying when it hits the fan. 'It's done wrong, because the client is too stupid to understand done-right' is not a place I a willingly going to put myself.

I guarantee that if one did a cost approach with a stated intended use of determining insurance replacement cost and an appropriate scope of work for that intended use and left out the site value (which has nothing to with insurance replacement cost) and left out depreciation (which again has nothing to do with insurance replacement cost), the underwriter would stip for these items and would not be able to understand why they were not included.

I have clients who have been taking reports like that from me for almost 15 years. Even if at first they have to ask what they are looking for, tell them what page it is on.