Chapter 5 Flashcards
The appraisal principle that states that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution. This is the primary principle upon which the cost and sales comparison approaches are based.
Principle of Substitution
Reproduction or Replacement Cost New
- Accrued Depreciation
+ Site Value
= Property Value
Cost Approach Formula
Cost Approach Formula Example
A very simplistic example would be as follows. A house cost $200,000 to build new. It is 10 years old and has sustained a total of 15% depreciation. It sits on a lot worth $40,000. What is its value by the cost approach?
Cost New $200,000 minus Accrued Depreciation ($200,000x.15) - $30,000 = $170,000
+ Site Value ($ 40,000)
= 210,000
A set of procedures through which a value indication is derived for the fee simple estate by estimating the current cost to construct a reproduction of (or replacement for) the existing structure, including an entrepreneurial incentive or profit, deducting depreciation from the total cost, and adding the estimated land value. Adjustments may then be made to the indicated value of the fee simple estate in the subject property to reflect the value of the property interest being appraised.
Cost Approach
Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.
Fee Simple Interest
The estimated cost to construct, at current prices as of the effective date of the appraisal, an exact duplicate or replica of the building being appraised, using the same materials, construction standards, design, layout, and quality of workmanship and embodying all the deficiencies, superadequacies, and obsolescence of the subject building
Reproduction Cost
The cost to create a virtual replica of the existing structure, employing the same design and similar building materials. The current cost of an identical new item.
Reproduction Cost
The estimated cost to construct, at current prices as of the effective appraisal date, a building with utility equivalent to the building being appraised, using modern materials and current standards, design and layout
Replacement Cost
The estimated cost to construct, at current prices as of a specific date, a substitute for a building or other improvements, using modern materials and current standards, design, and layout.
Replacement Cost
The amount an entrepreneur expects to receive for his or her contribution to a project. Entrepreneurial incentive may be distinguished from entrepreneurial profit (often called developer’s profit) in that it is the expectation of future profit as opposed to the profit actually earned on a development or improvement. The amount of entrepreneurial incentive required for a project represents the economic reward sufficient to motivate an entrepreneur to accept the risk of the project and to invest the time and money necessary in seeing the project through to completion
Entrepreneurial Incentive
In appraising, a loss in property value from any cause; the difference between the cost of an improvement on the effective date of the appraisal and the market value of the improvement on the same date.
Depreciation
In accounting, an allocation of the original cost of an asset, amortizing the cost of the asset’s life; calculated using a variety of standard techniques.
Depreciation
oldest, first approach to value
Cost Approach
Second approach to value after 1940’s
Sales Comparison appraoch
The most common type of approach to value today
Sales comparison approach
What approach or approaches to value are required by USPAP?
appraisers are required to develop whatever approaches are necessary to produce credible assignment results.
Fannie Mae may say the cost approach is not required - by them, BUT if the property is new….
the cost approach might be necessary for credible results.
A lack of market activity _________ the use of the sales comparison approach. You can’t use the sales comparison approach without a _______ amount of reliable sales _______
Precludes (prevents from happening); reasonable; data
The _________approach is best applied when the typical purchaser would be an investor who is buying the property for investment purposes.
income
You can virtually always do a ______ approach! I don’t care how old it is, what type of property it is, or what the market activity is. I can research a property, estimate its cost new, subtract apparent depreciation, and add site value.
cost
this approach is the one universal approach that can be applied to any kind of improved real property.
cost approach
This approach has good applicability when the improvements we are appraising are new or relatively new.
cost approach
The first step in this approach is to estimate the cost new of the building improvements. If it was recently built, it most likely was constructed of modern materials, utilizing modern construction techniques.
cost approach
The second step in this approach is the value of the land or site. If it’s a standard lot and there are adequate sales in the marketplace, it becomes a relatively easy and straightforward task to arrive at that value.
cost approach
The ideal situation for developing a cost approach is where the current building improvements truly do represent the _______ ___ ______ _____ of the land as though vacant. Any time we stray away from that ideal, there is potential for errors.
highest and best use
Special-purpose properties are sometimes called __-_______t properties. They represent things that are not normally bought and sold in the marketplace.
no-market
Let’s suppose you are asked to appraise a 30-year-old ranch house with a proposed addition that will include 800 square feet, three rooms, a full bath, and a fireplace. You may not be able to find sales of comparable properties that include an older house with a large, new addition. Assume the house will still be of single-family orientation and there would not be a market for such property as an investment. Which approach would you use?
Cost approach
The appraisal requires that land and improvements be valued ___________; such as for insurance or accounting purposes
seperately
The value of the land and the improvements also needs to be separated when considering _____________ for income tax purposes.
depreciation
Land value is a significant portion of the overall _______; such as with agricultural properties
value
When the cost approach is least applicable:
The depreciation is a type that is difficult to estimate
Data is scarce or lacking to estimate the amount of entrepreneurial profit
Data is scarce or lacking to estimate the land value
The interest valued is anything other than fee simple - adjustments must be made
True or false: Use the cost approach even if the depreciation is a type that’s difficult to estimate
false
True or false: You should void the cost approach if data is scarce or lacking to estimate the amount of entrepreneurial profit or the land value
true
The three legs supporting the value estimate by the cost approach:
cost, depreciation and land value
Tue or false: Avoid the interest valued is anything other than fee simple
True
The amount an entrepreneur expects to receive for his/her contribution to a project is
depreciation
entrepreneurial profit
entrepreneurial incentive
reproduction cost
entrepreneurial incentive
True or False: The cost approach is most applicable in situations where the site value is not well-supported.
False
The cost approach is primarily based on which valuation principle?
contribution
change
reconciliation
substitution
substitution
True or False: If appraising something other than fee simple interest, an appraiser can make an adjustment to the indicated value by cost approach in order to reflect the value of the property interest being appraised.
True
The estimated cost to construct, at current prices as of the effective date of the appraisal, an exact duplicate or replica of the building being appraised, using the same materials, construction standards, design, layout, and quality of workmanship and embodying all the deficiencies, superadequacies, and obsolescences of the subject building.
Reproduction Cost
The estimated cost to construct, at current prices as of a specific date, a substitute for a building or other improvements, using modern materials and current standards, design, and layout
Replacement Cost
Two basic ways to estimate what it would cost to build a subject’s building improvements brand new today
Reproduction costs
Replacement Costs
Most fire and casualty insurance is written to pay an amount equal to the _______ cost of the structure. That is an eye-opener to many people.
replacement
Certainly the majority of the appraisals performed today reflect the use of ________ cost if the cost approach is developed.
replacement
Where does this cost data come from? Cost data may be obtained from:
Construction contracts for similar properties Appraiser's files Local building contractors Professional cost estimators Cost estimating services
A prime source of cost data if you can get your hands on such contracts.
Construction contracts for similar properties
You may be able to obtain construction contracts for similar properties from
real estate agents, lenders, or other appraisers.
Every time you do an appraisal for a proposed construction, try to get a hold of and keep a _____ of the construction contract
copy
Who’s the first person you should ask about building costs?
the builder
These people are sources you must pay in order to obtain cost data
professional cost estimators
These services are not always 100% reliable, but they are probably the most commonly-utilized source of cost data for appraisers. There are several national ones.
Cost estimating services
The major cost estimating services are:
Marshall & Swift www.marshallswift.com
RS Means Company, Inc. www.rsmeans.com
The most popular cost service among residential appraisers.
Marshall and Swift
Whatever the source of the cost data, all cost estimates to be used in the cost approach need to include three basic ingredients:
Direct costs
Indirect costs
Entrepreneurial incentive
Expenditures for the labor and materials used in the construction of improvements; also called hard costs
Direct costs
Expenditures or allowances for items other than labor and materials that are necessary for construction, but are not typically part of the construction contract. Indirect costs may include administrative costs; professional fees; financing costs and the interest paid on construction loans; taxes and the builder’s or developer’s all-risk insurance during construction; and marketing, sales, and lease-up costs incurred to achieve occupancy or sale. Also called soft costs.
Indirect costs
The amount an entrepreneur expects to receive for his or her contribution to a project. Entrepreneurial incentive may be distinguished from entrepreneurial profit (often called developer’s profit) in that it is the expectation of future profit as opposed to the profit actually earned on a development or improvement. The amount of entrepreneurial incentive required for a project represents the economic reward sufficient to motivate an entrepreneur to accept the risk of the project and to invest the time and money necessary in seeing the project through to completion.
Entrepreneurial Incentive
Examples of tangible, hard direct costs:
Building permits
Materials used to construct buildings
Labor used to construct buildings
Examples of intangible, indirect costs
Architectural and engineering fees
Appraisal, accounting and legal fees
Cost of carrying the investment (e.g., construction loans)
Property insurance and taxes during construction
Entrepreneurial incentive is what a contractor or developer ______ to get; entrepreneurial profit is what they ________ get.
hopes; actually
Entrepreneurial incentive/ profit may be estimated as a percentage of:
Direct costs only
Direct and indirect costs
Direct and indirect costs plus site value
The value of the completed project
Cost services include direct and indirect costs in their cost figures - but NOT
entrepreneurial profits or incentives!
Most fire and casualty insurance policies are based on the ____________ cost of a structure.
reproduction
replacement
opportunity
original
replacement
Which of the following are the two major cost estimating services?
JD Power and R.L. Polka
R.L. Polka and Marshall & Swift
Marshall & Swift and RS Means Company, Inc.
RS Means Company, Inc. and JD Power
Marshall & Swift and RS Means Company, Inc.
When ____________ cost is used, it eliminates any functional obsolescence that may be present in the structure.
reproduction
replacement
book
opportunity
replacement
Direct costs are also called
soft costs
hard costs
entrepreneurial costs
opportunity cost
hard costs
There are three traditional cost estimating methods. They vary in degree of difficulty and accuracy.
They include the following:
Comparative-unit method
Unit-in-place method
Quantity survey method
If you know what the original cost of construction was for a building at some time in the past, it is possible through the use of special pages in cost services to apply a multiplier to bring it up to a present cost. in this limited situtation, which cost estimating method would you use?
the Index method
Using an index, you can calculate that a quart of milk that cost 10 cents at the time when it was delivered to your door now costs $1.48 from a store. Well, you can also use the same principle to find out what a house that cost $125,000 to construct in 1980 would cost today. This is an example of:
The index method
The contract cost for constructing a house in January 1996 was $324,500.
The index for January 1996 was 212.6 and the current index is 306.4.
306.4 / 212.6 = 1.441. This converts to a percentage as 144.1%.
Subtracting the 100% from the 144.1%, leaves 44.1% increase.
This means the costs have increased 44.1%.
$324,500 X 1.441 = $467,605
What is this an example of?
Cost index
A house contains 2,826 square feet. It was constructed in 1995 at a cost of $54.18 per SF.
The cost index at that time was 193.4.
The cost index today is 286.3.
What is the estimated cost to build the building today?
$226,607.
2,826 SF X $54.18 = $153,113
286.3 / 193.4 = 1.480
$153,113 x 1.480 = $226,607
Therefore, costs have gone up 48% since 1995, and it would cost $226,607 to build the same house today.
This is the first of the three traditional cost estimating methods. It is the simplest, quickest, least complicated, and least accurate method of estimating costs. It is the one that is used primarily by appraisers. Costs are expressed in terms of dollars per unit of area or volume.
Comparative-Unit Method
The steps of the comparative unit method:
Select sales of recently constructed buildings that are similar to the subject property and represent the highest and best use of the site
Subtract the value of the site and site improvements from the sales price to arrive at the cost new of the improvements (including entrepreneurial incentive)
Make adjustments for physical differences between the subject and the sale properties
Divide the adjusted cost new by the desired unit of area or volume to arrive at the cost per unit
Adjust the unit cost for market conditions, if necessary
Apply the unit costs to the subject property
You find a comparable sale of a new house similar to the one you are appraising.
It just sold for $320,000. You estimate the value of the site at $75,000 and the cost of the site improvements at $15,000.
$320,000 - $75,000 -$15,000 = $230,000.
The house has 2,550 square feet (SF) of gross living area (GLA).
What is the unit cost of the structure?
$90.20
All you have to do is divide $230,000 by 2,550 and the answer is $90.20. That is a market-derived comparative unit cost.
If your subject property has 2,475 SF, what should it cost to build?
2,475 x $90.20 = $223,245. That works well when the houses are about the same size. We will see later that the costs vary according to the size of the structure.
Okay, let’s do a quick cost approach for our subject property. Your research shows the land is worth $65,000 and you project the site improvements will cost $12,000. When completed, it will be brand new with no depreciation.
$223,245 - 0 + $65,000 + $12,000 = $300,245, rounded to $300,000.
A _____ _____ figure may be developed from cost services, such as Marshall & Swift. The same process applies, with adjustments made for differences from the benchmark structure and modifications for time and location of the subject.
unit cost
Tue or false: building costs vary from area to area
true
The easiest shape to construct is a _____ with __ corners
square; 4
The more corners you construct for a house, the more ________ it will be
expensive
In this method, total building cost is estimated by adding together the unit costs for the various building components. Sometimes it is called the segregated cost method.
Unit-in-place method
Costs are computed based on the quantity of materials used plus the labor involved in assembly. For example, costs could be estimated per square foot of floor area or lineal foot of wall area. For example, we might determine that the cost per lineal foot of exterior wall is $106.28. This is an example of the
unit-in-place method
This means running along the ground.
lineal foot
In this `method, the quantity and quality of all materials used and all categories of labor required are estimated, and unit cost figures are applied. The most comprehensive and accurate method
Quantity Survey Method
Of the traditional methods of cost estimating, the least complicated and least accurate method is the _________ method.
comparative-unit
quantity survey
unit-in-place
comparative-unit
When using Marshall & Swift, adjustments need to be made for construction costs in various locations of the country. This is accomplished through use of
quantity surveys
local multipliers
subjective guessing
entrepreneurial factors
local multipliers
A home was constructed in June 2009 at a cost of $195,000. The index for June 2009 was 188.2 and the current index is 218.3. What is the cost to construct the home today? (When dividing the indices, round to two decimal places)
$226,200
218.3/188.2 = 1.16
1.16 x 195,000 = 226,187
round two decimal places
226,200
The unit-in-place method is sometimes called the ____________ method.
segregated cost
quantity survey
comparative survey
reproduction cost
segregated cost
The cost approach has good applicability when the improvements we are appraising are \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_. old old, but remodeled new or relatively new historic
new or relatively new
The oldest of the three traditional appraisal approaches is the \_\_\_\_\_\_\_\_\_ approach. cost income capitalization sales comparison market
cost
Contractor’s overhead and profit is an example of ____________ cost.
direct
indirect
capital
none of the above
direct
“A loss in value from any cause” is the definition of what appraisal term?
Decline
Depreciation
Decreasing returns
Opportunity cost
depreciation
Appraisal, accounting and legal fees are examples of \_\_\_\_\_\_\_\_\_\_\_\_ costs. direct indirect entrepreneurial capital
indirect
All of the following are situations where the cost approach has good applicability, EXCEPT for
- the land value is well supported
- the improvements do not represent the highest and best use of the land as if vacant
- the improvements represent the highest and best use of the land as though vacant.
- estimating the use value of special purpose properties
the improvements do not represent the highest and best use of the land as if vacant
Unless adjustments are made for ownership interest, the cost approach will indicate the value of the ___________ interest.
leased fee
leasehold
fee simple
partial
fee simple
The basic principle underlying the cost approach is the principle of ___________.
anticipation
contribution
substitution
externalities
subsitution
A house contains 2,312 square feet. It was constructed in 2009 at a cost of $72.32 per SF. The cost index at that time was 201.4 and the cost index today is 265.8. What is the estimated cost to build the building today? (Round the index to 2 decimal places)
$220,709
The most popular cost service among residential appraisers is
Adobe Acrobat
Apex
Marshall & Swift
Alamode
Marshall & Swift
An example of a special purpose property is a ____________.
5,000 acre ranch
geodesic dome house
school building
8,000 square foot residence
school building
The cost to produce “an exact duplicate or replica of the building being appraised” is called _____________ cost.
reproduction
replacement
reproducible
insurable
reproduction
