AUTHOR: Patrick Egger is a Certified General Appraiser located in Las Vegas, NV. He teaches continuing education classes on the housing market, appraisal issues for real estate agents and appraisers. He can be reached at [email protected]
The URAR includes a number of sections that seem to be straight-forward, when in fact they are anything but. Continuing from Part 12 - Overlooked & Under-Reported, let's look at another often misunderstood area of the URAR . . .the Cost Approach!
Is the cost approach applicable and if so why? Before you automatically include the cost approach, consider the following.
- In a neighborhood that is void of vacant land or lots, similar to the subject site; does a potential buyer have the "construction new alternative"?
- In areas where housing is build in tracts or as builder production units (with economies of scale the typical individual does not have), is the cost approach valid?
- If (based on the above) you present the cost approach (whether or not any reliability is placed on it), by it's inclusion have you created a misleading report?
If building a new home is the "alternative to a home purchase", why use the cost approach when there is no land purchase option and or similar improvements can't be cost effectively duplicated?
URAR: Provide adequate information for the lender/client to replicate the below cost figures and calculations.
The space in this section is not sufficient to provide the level of detail for a reader to follow you sources and logic, step by step. If you include the cost approach, also include an addendum to expand on the methods used, land sales data, cost services, etc.
URAR: Support for the opinion of site value (summary of comparable land sales or other methods for estimating site value).
Vague statements or references ("from the appraiser's files" or "extracted") will cause a reader to question your support for the site value. Inexperienced appraisers often "pad" building cost estimates or minimize depreciation to make up for under-valued land in the cost approach. An experienced reviewer will recognize this type of mis-step immediately.
URAR: Type of Cost Approach - Estimated reproduction or replacement cost new.
FNMA Guidelines cite use of the "reproduction" cost new vs. the "replacement" cost for the subject property.
From FNMA: The reproduction cost estimate should reflect the cost of construction based on the current prices of producing a replica of the subject property being appraised - including all of its positive and negative characteristics. Although the construction materials used for the estimate should be as similar as possible to those used for the subject property, they do not have to be exactly the same.
Make sure you label the method used (reproduction or replacement) to estimate the cost of the subject property.
URAR: Comments on Cost Approach (gross living area calculations, depreciation, etc.).
Use this space to comment on depreciation or special considerations such as well costs, landscape, etc. These items should be consistent with your improvements description.
URAR: Estimated Remaining Economic Life (HUD and VA only)
The remaining economic life calculation assumes normal maintenance to protect the value of the property over its life. To estimate the REL, extract the indicators from the market and reconcile them. The basic method to accomplish this is as follows:
Subject property is 9 years old and similar to the following comparables.
Comparable #1 - $215,000 sale price, $65,000 estimated site value, 8 years old and in similar condition to the subject. Sale price minus the land value ($215,000 - $65,000) = $150,000. Replacement cost new estimated at $165,000. Therefore, market depreciation of $15,000 over 8 years or $1,875 per year or 1.14% annually ($1,875 / $165,000).
Comparable #2 - $225,000 sale price, $75,000 estimated site value, 5 years old, same condition as the subject. Sale price minus land value ($225,000 - $70,000) = $150,000. Replacement cost new estimated at $158,000. Therefore market depreciation of $8,000 over 5 years or $1,600 per year or 1.01% annually ($1,600 / $158,000).
Comparable #3 - $220,000 sale price, $60,000 estimated site value, 10 years old, similar condition. Sale price minus the land value ($220,000 - $60,000) = $160,000. Replacement cost new estimate of $176,000. Therefore market depreciation of $16,000 over 10 years or $1,600 per year or 0.91% annually ( $1,600 / $176,000).
Indicated annual depreciation correlated to 1% annually for the subject property. The subject is 9 years old, times the annual rate or 9% depreciated. 100% of the value minus the 9% depreciated - 91% remaining, divided by the expected annual rate of depreciation (1.0%) equals 91 years remaining. REL = 91 years.
With an Excel or similar spreadsheet program you can automate this process and track areas trends over time. Anytime you do the cost approach, add you notes for the subject in the spreadsheet. You might be surprised as to what the market's perception of depreciation and remaining economic life is.
Closing thoughts
A reader, intended user, etc. must be able to follow the appraiser's cost methodology and steps to produce the cost estimate. If you group items in the cost approach on the URAR, specify that you did in the comments area or addendum and provide details.
Often clients require the cost approach when its neither necessary or applicable. In most cases, they're looking to use the numbers to determine the level of insurance needed. If you provide a cost approach in your report, make sure you point out the definition of "insurable value" is not consistent with that of "market value" and as such, your cost estimate should not be used for insurance purposes.
Regardless of whether you choose to present the cost approach in the URAR or opt out, keep in mind that it can still be very useful. Cost estimates provide independent value conclusions, perspective on adjustments and will alert you to shifts in the market.
Next up, the 14th and final installment in the Outside the Boxes series, "Increase your ODDS ... Observe, Disclose, Disclaim and Specify".
AUTHOR: Patrick Egger is a Certified General Appraiser located in Las Vegas, NV. He teaches continuing education classes on the housing market, appraisal issues for real estate agents and appraisers. He can be reached at [email protected] Look for the new Outside The Boxes category for a collection of Patrick's articles on Appraisal Scoop!
Other Related Topics:
- The Cost Approach: To Do or Not To Do - E&O Alert
- Cost Approach - Including An Unreliable Approach - USPAP Q&A
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