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Why Is It That The Cost Approach Should Be Higher Than The Sales Approach Value?

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Valueseeker

Junior Member
Joined
May 19, 2016
Professional Status
Certified Residential Appraiser
State
Massachusetts
Hello again,

This is referring to when I had a supervisor he insisted that the cost approach figure is higher than the sales approach value so I always was mindful of this.

I get the theory of substitution that if it were cheaper to build the house than to buy it then the lender wouldn't like that very much.

My question is doesn't the cost approach factor depreciation? so even if the value is lower, can't you still say based on this value (just assume it's better to reconcile on this than the sales approach for arguements sake).

ex. Sales approach is 100k ; cost is 80k.

appraiser reconciles on cost approach as its more reliable than the sales given. (I have yet to do this- just arguing the point)

I guess I don't see how the theory of substitution would play in if the depreciation was 30%. You can't build it for that price as you would reset the depreciation if you did build it, but I'm saying it's worth 80k because of the depreciation.

Does this make sense? I know I'm missing something here but I'm hoping someone can help.

Thanks
 
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Meandering

Elite Member
Joined
Feb 26, 2006
Professional Status
Real Estate Agent or Broker
State
Pennsylvania
Try extracting you depreciation from the market instead of using Age/Life tables. This should bring your Cost Approach more inline with the Sales Comparison Approach, if your tables are over estimating the effect of depreciation in the market, or you are not accounting for any remodeling that has taken place, yet is not reflected in the Age/Life tables.

.
 

A K

Elite Member
Joined
Jul 31, 2013
Professional Status
Certified Residential Appraiser
State
Maryland
If the sales comparison approach to value is $100k and the cost approach to value is $80k then something is probably wrong. I would guess the cost approach is not being developed properly.
 

Michigan CG

Moderator
Staff member
Moderator
Joined
Nov 1, 2006
Professional Status
Certified General Appraiser
State
Michigan
This is referring to when I had a supervisor he insisted that the cost approach figure is higher than the sales approach value so I always was mindful of this.

I admire your question, hard one to ask on a national forum. Your supervisor was most likely clueless in terms of the Cost Approach. For your next CE take a Cost Approach class. There are three ways to do a cost approach. Only one is going to be applicable to you in most cases but learning all three will give you insight on how it all works.
 

CANative

Elite Member
Joined
Jun 18, 2003
Professional Status
Retired Appraiser
State
California
Are you including an amount or allowance for entrepreneurial incentive and other costs? An allowance of say 15% of total project costs would take that $80k up to $92k. You also might consider using the Extended Age/Life Method (a Marshall & Swift variation.) You can use Google to find explanations and tables.

Here is a freebie source that explains the cost approach quite well.

Use this link and then select AH501, Basic Appraisal. It's pdf handbook for "Appraisal 101" and it has a very good discussion on the cost approach.

http://www.boe.ca.gov/proptaxes/ahcont.htm

Here's a pdf of an M&S tutorial.

http://www.ncarea.org/images/CE-10-10.pdf
 

Valueseeker

Junior Member
Joined
May 19, 2016
Professional Status
Certified Residential Appraiser
State
Massachusetts
I've never had the cost approach be lower than the sales on the appraisals that I've done. I'm simply saying if it was could it be correct? And to reconcile on that value, would it be wrong?

Just hypothetically could that scenario ever happen or would something be wrong? Seeing the responses, it sounds like there would be an error in the development of the cost approach which then means it usually has to be higher in value- right?
 

Elliott

Elite Member
Joined
Apr 23, 2002
Professional Status
Certified General Appraiser
State
Oregon
There is theory and there is practice. Their is dogma and there is reason. CA is a theory, not much more.
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
CA is a theory, not much more.
No approach is theory. It is an approach based on market data, the same cost, sales, and income MARKET data all three approaches rely upon. Price Theory more closely describes what we do, microeconomic evaluation. Appraisal Theory, otoh, is a psychology theory related to responses to ones appraisal of a situation.
 

CANative

Elite Member
Joined
Jun 18, 2003
Professional Status
Retired Appraiser
State
California
I've never had the cost approach be lower than the sales on the appraisals that I've done. I'm simply saying if it was could it be correct? And to reconcile on that value, would it be wrong?

Just hypothetically could that scenario ever happen or would something be wrong? Seeing the responses, it sounds like there would be an error in the development of the cost approach which then means it usually has to be higher in value- right?

If the cost approach (done "correctly") is consistently lower than the sales approach it may indicate that the market is not in balance.
 
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