Sufficiency Of Cost Approach?

[BarrySW1963]

Questions for you reviewers...

How thorough does the cost approach have to be to be considered "sufficient"?

Here is an example from Marshall & Swift's swiftestimator plugin for TOTAL from a la mode.

Comments on the left hand side of the cost approach indicate "See Data Entry Report for details. Lot value was derived by the extraction method. As-Is Site Improvements include site preparations (including site clearing, level, fill, tap fees & electric meter loop), culverts, concrete drives/walks and yard landscaping. Per square foot cost includes the covered porch, patio and deck, the fireplace and the fencing (estimated linear feet of fencing), combined per software default."

The workfile contains printouts for what M&S considers to be included and not included on a generic basis for a quality rating of 4.0.

Do you consider this to be "enough"? Would you expect to see more details and data? What else would you expect to see in the workfile?

 

[Meandering]

Lot sales,

or data that will validate your extraction of the site value.

 

[Meandering]

The thing about "extraction" is the separation of external ob as it impacts an improved lot, versus the value of unimproved lots that may or may not be impacted by the same external ob.

And, there are some times when markets are in flux that the extraction will give you a much higher MV of the land, then is being realized by improved sales due to disincentives to build.

 

[J Grant]

Would be enough imo for most residential assignments

 

[CANative]

You need to come up with something better than stating "land value from extraction." Either find some sales or show your work (which is a lot harder than finding lot sales or sales of tear downs.)

Did you include a factor for entrepreneurial incentive?

 

[hastalavista]

I review.
For the typical residential cost approach, I would find your cost-data summary/source very acceptable (I'm presuming it is included in the addendum).
I would not consider the reference "site value by extraction" adequate. I would expect to see either a summary table of the extraction-process itself or a narrative walk-through. Remember: The GSE forms require that the data be provided so the client can "replicate" the process. From the 1004...



Note it says replicate the cost figures & calculations and a summary of the land sales or other methods for estimating the site value.
So your data sheet meets the cost figure requirement but the statement of "site value by extraction" does not meet the summary required for the site value analysis (IMO).

Site value by extraction is, effectively, reverse-engineering the cost approach on a known sale to get a site value. It is a recognized methodology and in cases where there are no lot sales to consider, it could be the best method available. A lot of appraisers dismiss this process yet it and "abstraction" are the two biggest methods cited in the reports that I read. And, a lot of appraisers dismiss the cost approach altogether yet it is unbelievable how close the indicated value by cost approach is to the final value opinion. I mean, the adjusted range of the sales comparables might have a 10% range, yet many times I see the cost approach indicated value within $5k to $25k on a $1,000,000 house. With that kind of accuracy, why do the Sales Comparison Approach?

In any event, your cost data is good. I recommend you summarize your extraction analysis: show the work in a table (that's what I do) or narrate it sufficiently so it can be replicated (that's what some others do).


Note: If the appraiser is doing a proposed construction valuation, the current site is vacant, and the client requires an as-is value along with as-if (Hypothetical Condition that the house is built on the day of inspection), then the appraiser MUST provide a sufficient-enough detailed analysis to support the as-is site value. Again, in reports I review, many appraisers just use the site value as indicated in the cost approach but they provide no site valuation analysis. Think about it: in a case where the client requires an as-is value and the site is vacant, just stating "value by extraction" would be the same as concluding the HC value via the cost approach without providing any analysis or grid, and simply stating, "Final value opinion based on Sales Comparison Approach." That would never fly for the HC value and, likewise, a reference to the process to determine the "as is" value shouldn't fly as well.

Good luck!

 

[BarrySW1963]

I review.
For the typical residential cost approach, I would find your cost-data summary/source very acceptable (I'm presuming it is included in the addendum).
I would not consider the reference "site value by extraction" adequate. I would expect to see either a summary table of the extraction-process itself or a narrative walk-through. Remember: The GSE forms require that the data be provided so the client can "replicate" the process. From the 1004...

View attachment 28489

Note it says replicate the cost figures & calculations and a summary of the land sales or other methods for estimating the site value.
So your data sheet meets the cost figure requirement but the statement of "site value by extraction" does not meet the summary required for the site value analysis (IMO).

Site value by extraction is, effectively, reverse-engineering the cost approach on a known sale to get a site value. It is a recognized methodology and in cases where there are no lot sales to consider, it could be the best method available. A lot of appraisers dismiss this process yet it and "abstraction" are the two biggest methods cited in the reports that I read. And, a lot of appraisers dismiss the cost approach altogether yet it is unbelievable how close the indicated value by cost approach is to the final value opinion. I mean, the adjusted range of the sales comparables might have a 10% range, yet many times I see the cost approach indicated value within $5k to $25k on a $1,000,000 house. With that kind of accuracy, why do the Sales Comparison Approach?

In any event, your cost data is good. I recommend you summarize your extraction analysis: show the work in a table (that's what I do) or narrate it sufficiently so it can be replicated (that's what some others do).


Note: If the appraiser is doing a proposed construction valuation, the current site is vacant, and the client requires an as-is value along with as-if (Hypothetical Condition that the house is built on the day of inspection), then the appraiser MUST provide a sufficient-enough detailed analysis to support the as-is site value. Again, in reports I review, many appraisers just use the site value as indicated in the cost approach but they provide no site valuation analysis. Think about it: in a case where the client requires an as-is value and the site is vacant, just stating "value by extraction" would be the same as concluding the HC value via the cost approach without providing any analysis or grid, and simply stating, "Final value opinion based on Sales Comparison Approach." That would never fly for the HC value and, likewise, a reference to the process to determine the "as is" value shouldn't fly as well.

Good luck!

Denis, thank you for weighing in. Tremendously helpful.

So, maybe you can help a little more.

Majority of assignments are in areas with either zero lot sales, or very few, and the few sales are rarely similar enough for use. That leads to extraction as most viable option. Sounds like a comment in the report is needed to walk through the extraction (replacement cost new of each comp, minus depreciation, subtract from sales price to get land value, divide by size of lot to get price per square foot of land, reconcile, then do the math for the subject's site size). Does that sound right to you?

Then, the next question. The software rolls up things like fences, decks, porches and fireplaces into the price per square foot for the dwelling, and doesn't permit splitting it out (and you can't see the underlying calculations/data in the monthly subscription package, only in the horribly expensive $11 per report package, but you can determine the numbers with a bunch of fiddling/software trickery). Do you feel like these items MUST be split out onto a separate cost line item to report on the 1004, or is is sufficient to handle it in a comment that says those items are rolled in? It also rolls up site prep into the dwelling cost per square foot with the same problem of not being able to see the underlying data breakdown. The as-is value of those items can be determined by combing through paper manuals, then subtracting the total from the software's dwelling cost per square foot line, but in doing so it makes the printed out supporting documentation from the software look fishy because doing that changes the price per square foot that is reported on the 1004. It would take a graphic flow chart to illustrate the fiddling necessary to avoid double dipping for the site prep/site improvements.

I've been comparing swiftestimator from a la mode (a TOTAL plugin, $13 per report or $75 per month unlimited, can import data directly into a 1004) with the tools on swiftestimator.com ($11 per report, no integration with TOTAL). The latter is FAR superior, and I've complained loudly and bitterly to a la mode that the version they offer is a severely limited version (with incomplete documentation to boot), despite all marketing materials (and even the screenshot on the a la mode store page) indicating it's the full-featured version. I also complained about it to M&S (CoreLogic) and they threw a la mode under the bus (and yes, I told that to a la mode, am waiting for a call back from someone more important who care why all of this matters).

(As an aside, for anyone that cares: probably the only advantage of the version offered by a la mode is that it prevents you from going down the granularity rabbit hole. Basically you can tell it GLA, bath count, garage size, some info on porches/patios and fencing, exterior materials and roofing, and heating/cooling. You can't reasonably add/subtract for superior/inferior interior features, but can adjust the overall quality level in 10% increments within each quality band.

 

[hastalavista]

Denis, thank you for weighing in. Tremendously helpful.

So, maybe you can help a little more.

Majority of assignments are in areas with either zero lot sales, or very few, and the few sales are rarely similar enough for use. That leads to extraction as most viable option. Sounds like a comment in the report is needed to walk through the extraction (replacement cost new of each comp, minus depreciation, subtract from sales price to get land value, divide by size of lot to get price per square foot of land, reconcile, then do the math for the subject's site size). Does that sound right to you?

Yest it does. I don't know what how excel-savvy you are, but I do this in excel and put that summary into the report. One doesn't have to.. but since this is how I do my extraction I might as well.

Then, the next question. The software rolls up things like fences, decks, porches and fireplaces into the price per square foot for the dwelling, and doesn't permit splitting it out (and you can't see the underlying calculations/data in the monthly subscription package, only in the horribly expensive $11 per report package, but you can determine the numbers with a bunch of fiddling/software trickery). Do you feel like these items MUST be split out onto a separate cost line item to report on the 1004, or is is sufficient to handle it in a comment that says those items are rolled in? It also rolls up site prep into the dwelling cost per square foot with the same problem of not being able to see the underlying data breakdown. The as-is value of those items can be determined by combing through paper manuals, then subtracting the total from the software's dwelling cost per square foot line, but in doing so it makes the printed out supporting documentation from the software look fishy because doing that changes the price per square foot that is reported on the 1004. It would take a graphic flow chart to illustrate the fiddling necessary to avoid double dipping for the site prep/site improvements.

The cost approach section in the 1004 is compartmentalized as follows:
As-is site value
RCN which is subject to depreciation.
Contributory value of the as-site improvements (which are valued as-is, and therefore any depreciation is already baked into that estimate).

IMO, fireplaces should be included in the RCN. There is an argument that if porches/decks are attached to the improvement, they become part of that RCN total as well. I'm fine with that.
Fences, IMO, are similar to walkways, driveways (hardscape or flatwork as it is called) and landscaping. I've always considered this to be site improvements and have identified them below the RCN line. Are you sure that fencing is included in the M&S improvement section? But, as to its significance, I don't think it is a big deal.

M&S is a recognized source, so it is a "safe haven" to use in a typical residential cost approach. And beats the hell out of "local builders"*. So you are "safe" for using it as a source. You could breakout the fence cost if you like, but I don't think it is necessary. I'd "up" a report's quality-rating if it informed me that fencing was included in the RCN of the improvement rather than the site-improvements and that, in the report's opinion, that inclusion does not affect the reliability of the analysis. But I wouldn't "ding" a report if indeed, M&S includes the fence in the RCN and the report doesn't mention it. As you point out, if it is in the RCN, just don't include it in the "as-is" value of the site improvements (and, it probably makes sense to state that those items are in the RCN per M&S just in case you get a really anal reviewer).

Good luck!


*(I teach a Residential Cost Approach CE course: I caution the attendees to my course that if the put "local builders" as a source, they better have them in their workfile because it is one of the first things our regulator is going to ask for. Now, some appraisers- including myself- actually have local builder estimates for homes that we've done... so if I include a "local builder" as a source, I include that builder's name. My personal preference is when I'm doing a proposed construction, I'll take the contractors bid and run it against my building-cost sources anyway to test its reasonableness. I'll include my independent cost-estimate as well as the builder's).

BTW, CANative asked if you include EI (Entrepreneurial Incentive) in your analysis. Since he opened that can of worms, I'll let him advocate for its inclusion (which I agree with). Whether you do or don't, I advise you to understand what it is and how it impacts the Cost Approach Analysis, and then form your opinion if it should be included or not. This way, you'll be able to defend your position if ever asked.


Good luck!

 

[Mark K]

I mean, the adjusted range of the sales comparables might have a 10% range, yet many times I see the cost approach indicated value within $5k to $25k on a $1,000,000 house. With that kind of accuracy, why do the Sales Comparison Approach?

Because in most cases where it claims that level of accuracy, the Cost Approach was manipulated and 'backed into' to make it fit.

 

[bnmappraisal]

*(I teach a Residential Cost Approach CE course: I caution the attendees to my course that if the put "local builders" as a source, they better have them in their workfile because it is one of the first things our regulator is going to ask for. Now, some appraisers- including myself- actually have local builder estimates for homes that we've done... so if I include a "local builder" as a source, I include that builder's name

Great point!

I thought it was worth repeating (my bold)