About the author: Gretchen Gary is a real estate professional who specializes in the Cost Approach. From 2003 to 2006, she published articles warning about the pending housing market crash, and promoted the Cost Approach as a quality control for property valuations.
Industry Spotlight: The New Cost Approach By Gretchen Gary
Years of unrestrained lending practice have delivered the most tumultuous housing market since the Great Depression. And speaking from the perspective of the appraisal industry, it doesn’t come as much of a surprise.
These days, it’s no secret that appraisers were pressured to hit the target price of a sales contract as common practice throughout the housing boom. The market was hot, and demand relentless. Market-based appraisals were turning out hyper-inflated values with outrageous appreciation, and most everyone knew it. A housing bubble was bulging unchecked and real estate prices were through the roof.
Now in the wake of a massive housing crisis, industry heavyweights and government officials are stepping in to bring some regulation to the industry. Unfortunately however, only appraisers really know what is needed to ensure honest valuations. The proposed guidelines of Freddie Mac’s Home Valuation Code of Conduct miss the mark.
While the prevalence of inflated home values originated from unbridled lending, only responsible appraisal practice can bring this crisis to head. The industry already has its own valuation quality control method in the Cost Approach. Now is the time for appraisers to define their own professional code of conduct by re-evaluating the common valuation process.
The Cost Approach Today The demands and disappointments of today’s housing industry have created a renewed interest in the Cost Approach.
Typically recommended for unique properties, new or proposed construction, and properties with specialized improvements, the Cost Approach appraises a property based on the value of the land plus the estimated replacement cost new of the building less depreciation. Its practical approach to value also provides a trustworthy benchmark that can be used to validate market-based appraisals. With a cost-based perspective on the market, the appraiser gains insight on value sustainability and a more comprehensive picture of the property valuation.
Historically, the Cost Approach has always served a quality control function, used to help identify a potentially runaway or rapidly declining market. Throughout the housing boom, Cost Approach valuations were signaling inflated market-based values beyond sustainable levels. The subsequent bust came as little surprise to proponents of the Cost Approach.
As the industry reels from the effects of questionable lending, the Cost Approach presents a way to prevent another bubble scenario in the future.