Low-Cost E&O Insurance from OREP Working RE Home Library/Previous Editions
Cost Approach: Why
Sidestepping it can be Costly -
read story
> “In the current market I find
the Cost Approach to be an unreliable indicator of value. This is due to
the decline in prices versus the stable or in some cases, increasing cost to
build. Those costs, in my area, sometimes reach as much as 35-40 percent above
the market price of a home. I always include a caveat regarding the reliability
of the Cost Approach as an indicator of value.” - Robert Coop, NV
> “I have been running Marshall & Swift on every residential
appraisal for the past year and a half. It is not time consuming once you learn
how. Some say it doesn’t apply to older homes. When the proper effective age is
entered, I find it works for homes of all ages and is a good cross check to the
market approach.” - William R. Getter
> “Nowhere in the article does it mention entrepreneurial profit, which
is a major ingredient in the Cost Approach. This profit, in most cases,
is derived from the value indication in the Sales Comparison Approach and on
occasion from the Income Capitalization Approach. In a ‘down
market,’ entrepreneurial profit is replaced by External or Economic
Obsolescence.” - Stephen H. Schuster, MAI
> “In the old days, ‘Market Approach’ and ‘Sales Approach’ were used
synonymously. But many years ago it was noted that all approaches to value are
market approaches, so the interchange of these two terms became a thing of the
past. Thanks for the article.” - Bruce Morgan, Certified General Massachusetts
Appraiser
> “For residential appraisers, the Market Analysis is still the most reliable
approach to value unless a full land valuation is also undertaken. Even this
becomes a significant problem in fully developed areas.” - Marshall Crawford
> “Your article on the Cost Approach is sadly lacking in a variety of
ways. The most obvious is the use of the phrase ‘market approach’ instead of
‘sales comparison approach.’ I can appreciate that the authors are not
appraisers and are trying to provide public relations for their valuable
product- which I use regularly. But this is no excuse for their use of archaic
terminology and their missing key aspects of the very method they are trying to
promote and their product does so much to obtain.” - Kevin Casserly
> “I respectfully request that you also reprint the story Cost Approach- a
Different View: Perpetuating the Myths. This way readers have the pros and
cons.” - George K. Cox, MAI, SRA
Editor’s Note:
You’ll find this story,
authored by Mr. Cox, at WorkingRE.com in the
Premium Content area (Cost
Approach: a Different View)
> “I agree that the Cost Approach does indeed provide an appropriate
perspective that should temper the opinion reported in the appraisal. The
comments in this article are, in my opinion, theoretically correct on a
fundamental basis regarding the sustainability of a value estimate. An
appraiser, however, is charged with predicting market behavior as of a specific
date regardless of the long term prospects. Comments in the appraisal regarding
the market and long term trends should sound the warning bells to the client and
underwriting decisions should be made accordingly. Do most lenders actually read
the report and make responsible decisions based on reported market conditions?
Most probably don’t. But to imply that the appraiser should report a value
lower than what the market is actually paying as of the effective date of the
appraisal is not a reasonable expectation, nor should it be.” - Michael C.
McCall, MAI
> “I use the Cost Approach when it is appropriate, which is as it should
be used, not just for the sake of filling in a portion of a form.” - Linda
Busick
> “Are you kidding? When is an appraiser supposed to be concerned with
sustainable value? Have you read the definition of market value? Market value
reflects a hypothetical sale or closed sale as of the date of value which
assumes exposure on the market has already occurred. If you have a market that
is exploding upward or downward, the goal of a market value appraisal is not to
estimate what the property will sell for in the future but what it would have
sold for as of the date of value. If you have recent sales data including
pending sales and recent closed, that's what value should be based on but
considering current trends. If the Cost Approach is considerably higher
or lower than the market approach and your cost factors and depreciation are
accurate, the problem is your land value is wrong; not that the value estimate
is wrong if you have based it on current relevant sale date.” – (name withheld)
> “I read the article about including the Cost Approach on reports,
though it is no longer required by Fannie Mae for some properties. Then I read
the bottom line about the authors and was disappointed. Having Marshall &
Swift executives write this article tends to negate its validity.” - (name
withheld)
Editor’s Note:
It is the opinion of WRE that
being a vendor should not disqualify one from contributing editorial content as
long as the story fits the criteria of the magazine: that is, to be helpful to
readers. In fact, many vendors are experts in their fields and have much to
contribute. We do not believe a story’s content should be disregarded solely on
the basis of its author.
Replacement
Cost New Estimate
(RCN)
> “I was
dismayed to see that you had paid only passing notice of the pressure and abuse
of appraisers by the lenders and others sneaking under the appraiser's tent.
Prior to the half dozen hurricanes that hit Florida before we ever heard of
Katrina, residential appraisers were dutifully filling out the Fannie Mae
residential appraisal forms and/or preparing a form used to cut the lender's
costs. We were secure in the knowledge that our statements of qualifying and
limiting conditions, coupled with the stated purpose of the appraisal for
lending underwriting (only), would protect us from liability. So what happened?
"The lending industry (banks and mortgage brokers) began handing out our
appraisals to unintended users and particularly to property insurance agents.
Those agents, instead of doing their own calculations and replacement cost new
estimates- as they had been doing for decades, decided to steal the appraiser's
calculations and base their insured values on the appraiser’s RCN (replacement
cost new estimate) in the form of the Cost Approach. They were not
intended users but that didn't matter when hurricanes and fires devastated south
and central Florida.
"An underinsured property owner bypassed the insurance agent and successfully
sued an appraiser claiming the appraiser's RCN in the report's Cost Approach
caused the fire damaged commercial building to be underinsured. The
insurance agent/company had successfully shifted liability for their property
insurance coverage decisions to the lowly appraiser.
"As a result, for a fee of $250-$300 or $600-$750 for commercial reports,
appraisers are now on the hook for insurance coverage quality RCN, even though
the intended user was the mortgage lender and the purpose of the appraisal was
to report market value, not insurance value. To add insult to injury, the
'leadership' at Fannie Mae and Freddie Mac forced a new set of rules on the
appraisers that overrode the appraiser's limitations on the number and type of
users of the appraisal. Thus, it is now impossible for appraisers to prevent the
misuse of their appraisal report by the suddenly lazy insurance industry and
anybody else because the Feds opened the appraisal report to a flood of
unintended users. As a result, those appraisers with any brains quit using the
Cost Approach on the Fed's residential forms with their mandatory clauses
for open ended use.
"The constant pressure from lenders and their newly invented appraisal
management companies forced many appraisal fees down to $200 or less. The net
result of this activity has lowered appraisal fees while simultaneously
expanding the appraiser's liability to include among others- insurance/insurable
value. What a bargain for the mortgage brokers, banks, and insurance industry!
Free RCN with no liability for accuracy or quality on their part.
"Despite the appraisal industry's response to emphasize ‘Scope of Work’ and
‘Intended User,’ the ‘giveitaway’ to everybody clause still remains in the
federal appraisal forms. The problem persists. Within the past year, I have
received innumerable requests from property owners, in danger of losing their
property insurance coverage, for ‘appraisals’ because the State of Florida's
insurer of last resort, Citizens Insurance (a state run insurance pool) is
demanding real estate appraisals of their properties. Trying to explain to these
property owners that what is needed is a RCN and not an appraisal of their
property's market value is a losing proposition. They do not want to pay the
cost of a thorough RCN estimate. And Citizens expected to shift their liability
for proper RCN calculations onto the appraiser for the measly fee of $200-$300.
So, Citizens would not do RCN calculations. And property owners could not
afford to get the ultimate authorities - local building contractors - to
estimate RCN for their buildings.
"Why the insurance industry doesn't go back to using their own RCN calculations
is no mystery when Fed appraisal forms continue to include a stripped down
version of a Cost Approach with a RCN line item. For the appraiser dumb
enough to prepare a Cost Approach on the appraisal forms, the liability
is staggering!” - Dan K. Richardson, PhD, MAI, AICP