A lot of appraisers were thrilled when FannieMae, et al made their great announcement. Which great announcement? FannieMae publishes announcements all the time. It was when they announced they would no longer require the Cost approach to be part of an appraisal.
Hooray, a real time saver! Thank you FannieMae et al! The Cost approach is a waste of time anyway! Nobody understands accrued depreciation. Even builders cannot decide on what’s a hard cost, a soft cost, and overhead. And that entrepreneurial profit/incentive thing! What difference do they make anyhow?! The house is up and built! People don’t expect an entrepreneurial profit/incentive when they sell their house, so why have to worry about it in an appraisal!? Give me three recent sales in the same neighborhood, and I’m in and out of that appraisal in no more than four hours! Cha-ching! That’s how I can put some money in the bank! Besides, I always back into the Cost approach from the Sales Comparison approach!
Perhaps, there is another facet of the issue to consider?
It’s true “the market” does not typically does not use the Cost approach to buy and sell houses. It’s also true we appraisers enshrine the market and its trends. That’s what we do. So, if we enshrine the market, why are we willing to ignore what it tells us? But, how do we ignore it if that’s not how the market trades houses? Simple. True, the Cost approach may not talk to us in a transcendent baritone. It more likely advises us sotto voce. We listen when the market “talks” to us. Why are we less disposed to accept its advice when it merely whispers? Lovers whisper; antagonists SHOUT.
So, how does the Cost approach whisper the market’s trends to us? There are at least two ways it communicates market trends to us, if we will but listen.
The first is thru accrued depreciation. Many appraisers take accrued depreciation from published depreciation tables. There is no question these are mathematically correct. However, these tables assume residential housing wears out at a more-or-less curvilinear rate. That rate indicates little depreciation per year when a property is new, then more per year as it ages. This, too, is true. These tables, however, do not and cannot account for incredibly hot markets, or dead ones. What do these mean?
An incredibly hot market may see the man-made improvements to a site actually appreciate in value. Yes, this is a function of speculation. A speculative market is not one that meets the definition of market value. Yet they exist and we have to interpret them. The published tables do not reflect this market condition, so we have to.
Next, to consider is that dead market. Prices have fallen faster than a Senator’s job-efficiency ratings. Our broker friends tell us the properties are selling for little more than land value. Again, the published tables do not and cannot reflect this situation.
In other words, the published tables are at their most accurate in a flat market. How many of those have you seen in the last 10-years?