INTRODUCTION
It is clear most appraisers do not like to do the Cost approach. Generally, we are not too familiar with it. So, it is clear that most appraisers, because of this, do not appreciate the deep analytical power the Cost approach really has. Therefore, I’m going to ask you 10 questions on the Cost approach (and stuff related to it). After you’ve finished reading them, you probably will still not like to tackle the Cost approach. Nevertheless, you just may have a better understanding of, and appreciation for, its powerful analytical capacities.
THE QUESTIONS START HERE
Remember, the answers to these 10 questions is, at least in large part, comes from engaging in the analytics inherent in the Cost approach. Thus, if you are not engaging in those analytics, are you missing out on the answers to these questions? Is that something you want to explain to a state appraisal board?
Here are 10 questions on the Cost approach (could there be more?):
- On the 1004 form is the indication that Fannie Mae does not require the Cost Approach to Value. Where does the form instruct the appraiser not to complete the analytics of the Cost approach?
- Instruction on the form state the appraiser is to “…[p]rovide adequate information to the lender/client to replicate the [herein] cost figures and calculations”. Where does the typical appraiser provide such replicable information?
- In addition, the report form requires the appraiser to “…[s]upport the opinion of site value [with a] summary of comparable land sales or other methods for estimating site value”. Where in the report does the typical appraiser provide such summary information?
- Consider this quote from the Fannie Mae Selling Guide, from Highest and Best Use (italics added to the quote). Is this part of your highest and best use analytics?
“The appraiser’s highest and best use analysis of the subject property should consider the property as it is improved. This treatment recognizes that the existing improvements should continue in use until it is financially feasible to remove the dwelling and build a new one, or to renovate the existing dwelling. If the use of comparable sales demonstrates that the improvements are reasonably typical and compatible with market demand for the neighborhood, and the present improvements contribute to the value of the subject property so that its value is greater than the estimated vacant site value, the appraiser should consider the existing use as reasonable and report it as the highest and best use”.
THE 10 QUESTIONS CONTINUE HERE
- So, it is clear from these instructions the appraisal of a SFR includes an analysis and valuation of the subject site separate from the valuation of the site as improved. This means as if the subject site were vacant and available to be put to its highest and best use. Do you have those analytics in your report or your workfile?
- Suppose the appraiser was not aware of the market value of the subject site as if vacant, as well as not aware of the market values of the comparable sales as if vacant. How, then would it possible to adjust for differences in the components of comparables’ site values?
- How is it possible to make an age/condition adjustment if the appraiser does not know how much the age and the condition of the subject and the comps contribute to their respective market values?
- Assume the appraiser has not determined if there is or is not an entrepreneurial value or profit in the market. This is normally part of the protocols of the Cost approach (or it should be). How, then, can the appraiser determine if construction new is financially feasible? In line with this, how could the appraiser determine if repairs, renovations, or razing the improvements is financially feasible?
- How is the level of market demand (as indicated by the presence/absence of an entrepreneurial incentive or profit) an integral function of the highest and best use process?
- How does the presence or absence of an entrepreneurial incentive or profit help the appraiser to determine the stage at which a neighborhood finds itself as of the effective date of an appraisal?
SUMMARY AND CALL TO ACTION
Has this series of 10 questions helped you to understand the deep power there is in the protocols and analytics of the Cost approach? I’m available to consult with you on the Cost approach, or any real estate appraisal-related topic. We can consult on a one-time basis, or on an on-going coach/mentor basis. Please contact me, Tim Andersen, for the details at tim@theappraisersadvocate.com. It will be my honor to work with you! Be safe and well!
Oh! By the way, one more question: Are your professional fees high enough?
Thanks!
Tim,
It is overwhelmingly obvious that there is intense interest about the cost approach among your respondents so to heck with everybody else. It would be consuming to publish the answers by the bloggers above to your questions and encourage critical thought among them. So far when I have tried this it attracts the trolls among us and it turns out badly.
I suggest a couple of rules if you can bring yourself to try this experiment.
1. No trolling.
2. No trolling.
Could you re-write the questions so I can understand them?
Edd, thank you for your kind remarks. Avoid the trolls and talk with me instead! You have my number. As to you understanding of the questions, you already understand them, you just may not realize that yet. So, call me! We’re friends!
What I consider remiss of the 1004 form is the fact that the GSE’s do not require it. As a result, the vast majority of appraisers do not complete it. Over time, the last 15 years anyway, appraisers have lost the value of it. The connectivity of the HBU analysis with the CA has also been missed. When did it become OK to disregard USPAP Standards 1 and 2 in considering ALL 3 approaches to value in the development of the opinion of value? Appraising real property in promoting public trust should never be told an essential component of analysis is not required. The robotics of the process will take that directive as a pass. This has become the new normal and, sadly, going back to our roots is a difficult battle.
Terri, Thank you for your thoughts and comments. Thank you, too, for taking the time to read the post. Clearly, we both conclude the Cost approach is more important to the analytics behind an appraisal that many appraisers want to conclude. You are very kind to share your feelings. Thanks again! Be safe and well! My Best to you and all of yours!
For me, the highest and best use of the cost approach is to support other assignment results. Site value and HBU as you point out; but also effective age and remaining economic life. When you have supported remaining economic life, you know the market value of the improvements as a percentage of cost. Now you can apply that percentage to things like GLA, baths and garage stalls. Use those adjustments in the sales grid and you have a coherent report free from the problems of using messy MLS data to extract adjustments.
Well said, Scott, Thank you!
I personally consider it appraiser malpractice to not use land sales in an appraisal report, when available. I live in the foothills of California, a mostly rural landscape with plenty of land sales and listings. The last report I completed, I noted 75 active listings of vacant sites. I complete an absorption rate and list the available vacant land sales & listings. What do I get from land sales? I support subject’s estimated land value. I support the depreciation models. I support view adjustments, I support site size adjustments, I support adjustments for location (busy streets), I can get all of this from land sales. Example, I reviewed a small development of 12 parcels. 2 of the 12 parcels front a busy street. These 2 properties sold at lot premium of minus 8%. The 2 backs lots had valley views and sold at a 12%+ premium. No cost approach, no support… The AMC replies, I wanted the report yesterday!
This is great, thank you!