The Cost Approach Made Simple

The Cost Approach is a somewhat controversial subject. Is it required by the new Fannie Mae forms? Does USPAP require it? FHA? Manufactured housing? These are questions for which you will probably have to answer yourself. However, when you do need to use the cost approach, it’s good to know how it works.

This is the first in a series of three articles about the Cost Approach appraisal method. In this article, we will review how the Cost Approach method works and when it should be used. In the second and third installments of the series, we’ll show you some useful appraisal resources and how you can quickly and easily create Cost Approach estimates using SwiftEstimator™ for ClickFORMS™.

The Cost Approach Appraisal Method – Part 1

Verifying market and income based valuations

Most appraisers know that using the Cost Approach is an essential method for appraising one-of-a-kind and special-use properties. But what may come as a surprise is the wide range of opportunities where the cost approach can help verify your market and income-based valuations.

What is the cost approach?

The cost approach method is, quite simply, an estimate of the replacement value of a property that’s determined by the cost of its components – land and improvements. Based on the principle of substitution, the cost approach method in essence says, you shouldn’t pay more for a property than the cost of a comparable site and building. Rather than valuing property as a whole, the cost approach adds up the separate values of the land and improvements.
Here’s how it works:

• Estimate the value of the land as if vacant.
• Estimate the replacement cost of the building.
• Estimate the building’s loss in value from depreciation.
• Subtract the building’s depreciation from the estimated replacement cost.
• Calculate the value of the property by adding the estimated land value to the depreciated value of the building.

When to Use the Cost Approach

You’ll find that the cost approach method is particularly useful in situations when market data is scarce, the property value significantly exceeds its replacement cost, prices surge due to housing shortages and increased demand, and of course those properties that have unique or one-of-a-kind features.

And in markets where demand for new housing outstrips the available supply, appraisers are faced with the challenge of accurately estimating properties that run the risk of significantly losing value after supply catches up. Estimating property valuations in type of environment using a market-based approach alone may mislead clients into believing that the market is sustainable.

The cost approach gives appraisers a pure cost-based perspective on the market and their clients a more complete picture of the property valuation.

The cost approach can be used in a number of appraisal applications – and not just because it’s required. You can use this method to add validation to your appraisal.
Here are some applications:

• Use an independent valuation method - Appraise manufactured homes
• Value unique property features - Monitor local real estate markets
• FHA appraisals

Fannie Mae’s cost approach requirement for manufactured housing

Manufactured housing represents one of the fastest-growing housing markets in the US. Fannie Mae’s investment in manufactured housing is part of its larger mission to expand affordable housing to Americans of modest means. However, in recent years, there are fewer financing options available today for manufactured homes. Industry analysts estimate that the number of repossessed and foreclosed manufactured homes is at record high levels.

Manufactured homes are built on a permanent chassis at a factory and then transported to a permanent site and attached to a foundation.

In an effort to help ensure that consumers purchasing a manufactured home do not pay more for the house than it is worth, Fannie Mae in June 2003 announced that all market-based property valuations must be supplemented with Cost Approach appraisals.

Appraisers must now qualify their opinions on the quality and condition of the manufactured home when filling out the Manufactured Home Appraisal Report Addendum (Form 1004C).

These new appraisal requirements are part of Fannie Mae’s ongoing effort to improve lending practices in the manufactured housing market, and ensure that people have opportunities for successful, long-term homeownership under financing terms that are appropriate for this housing type.

Getting the whole story

In an increasingly complex and dynamic real estate market, appraisers are challenged to provide estimates that are accurate, reliable and complete to their clients. Appraisers are finding that using the market-based approach alone is no longer enough. As a result, appraisers are relying more on the Cost Approach method to verify the validity of a property’s market value and for the confidence their clients are getting the whole story.

The Cost Approach – Part 2

This is the second in a series of three articles about the Cost Approach appraisal method. In this article, we will review some useful appraisal tools and resources that can assist you in creating your Cost Approach estimates. In our third and final installment, we’ll show you how you can easily integrate a cost approach estimate in your next ClickFORMS appraisal.

Easy-to-use Cost-Approach tools and resources

In our last article we described the benefits of the Cost Approach method and when it should be used. In this edition, we’ll look at some tools and resources that can help you with the process of creating your own Cost Approach appraisals quickly and easily.

Every appraiser has different needs, preferences, and ways of working. Fortunately, there are several Cost Approach books, CDs, and online resources to choose from to meet your unique requirements. Whether it’s a tutorial or reference guide, having the right tool on hand to answer your questions can help you get started as well as boost your productivity.

Handy Reference Guides and Manuals

Residential Cost Handbook from Marshall and Swift

This comprehensive reference provides cost data for estimating basic single-family site built homes, low-rise multi-family apartment buildings, manufactured homes, older homes, town houses, duplexes, and even urban row houses. Using clear and easy-to-understand definitions of basic residential styles, photographs and illustrations, you can distinguish between six residence quality levels, ranging from low to excellent.

Also included are expanding depreciation tables, estimated lives of replaceable building components, insurance exclusions, architects' fees, construction time, insulation requirements as well as climate classifications.

Tip: The customized forms provided in this manual guide you through the data collection and calculation process and assist you in the completing your cost approach valuations.

N.A.D.A. Manufactured Housing Appraisal Guide & CD

This popular appraisal guide, which uses the Fannie Mae and Freddie Mac approved cost approach, is used by more lenders, insurance companies, retailers and federal/state agencies than any other mobile, modular and manufactured housing publication. The N.A.D.A. Manufactured Housing Appraisal Guide provides 40 model years of information on more than 750 manufacturers and over 6000 trade names. To simplify the valuation process, detailed, market specific data and in-depth adjustment guideline tables are also provided. This package set also includes a CD-ROM with built-in dynamic calculators and printable reports. This price guide and CD-ROM set simplifies the task of accurately obtaining market-reflective pricing in today’s dynamic manufactured housing market.

Convenient Online and Computer-based Resources and Tools

CD – Residential Estimator 7 from Marshall and Swift

This easy-to-use Windows application enables you to create unlimited cost approach reports. With access to accurate costs on every type of residence, and extensive coverage of component costs, Residential Estimator 7 will help you produce accurate reports quickly and efficiently.

Simply enter the assignment-specific building data into the specified fields and let the program pull all related cost figures, calculate totals and produce entire reports. A key resource to your business, your annual subscription fee of $709.95 includes quarterly updates and unlimited use of our free technical support services.

Residential Estimator on the Web from Marshall and Swift ($8 per transaction)

This web-based version of Residential Estimator allows you to easily create Standard, Short, Input Listing and Depreciation cost reports as well as Form 1007 for FHA and HUD appraisals for single-family and low-rise multi-family residences, townhouses and duplexes. And with real time data updates you can rely on current and accurate data, prepare cleaner, sharper reports and have the confidence that your cost estimates are reliable and accurate.

Residential Estimator on the Web allows you to simply pay-as-you-go for the calculations you need. Your credit card will automatically be charged after each session. You can even re-calculate and make adjustments to your report for 7-days at no charge.

Tip: SwiftEstimator charges are calculated per section. One section may be all that is needed to complete a building report. There may be cases where more than one section is needed to complete an estimate.

SwiftEstimator for ClickFORMS

SwiftEstimator, with its seamless integration with ClickFORMS, enables users to use the Cost Approach method to accurately verify market-based valuations, project construction costs, adjust estimates for unique physical property features and monitor real estate markets.

ClickFORMS combined with the web-based version of SwiftEstimator provides an integrated solution that eliminates the complexity of using the Cost Approach to determine property value. Creating standard, short, input listing and deprecation cost reports is a breeze using the SwiftEstimator online forms and intuitive user interface. And Form 1007 for FHA and HUD appraisals for single-family and low-rise multi-family residences, townhouses and duplexes are quick to create and later adjust as new information becomes available.

More information on how SwiftEstimator for ClickFORMS can help enhance your Cost Approach appraisals is coming in our next edition of ClickTalk.

Fannie Mae Manufactured Home Appraisal Report Addendum (Form 1004C)

In an effort to enhance the quality of manufactured home appraisals, Fannie Mae requires that a detailed and supported cost approach be added to all manufactured housing appraisals. Now when completing the Manufactured Home Appraisal Report Addendum (Form 1004C), appraisers must qualify their opinions surrounding the quality and condition of the manufactured home in question, meanwhile providing lenders with additional information, and improving the financial institution’s ability to underwrite.

The link to the Fannie Mae’s Form 1004C listed above provides useful information and background on these cost approach requirements.

Coming in our next edition: Learn how to integrate a cost approach estimate in your next ClickFORMS appraisal.

The Cost Approach – Part 3

This is the final installment in a series of three articles about the Cost Approach appraisal method. In our last edition, we provided information on some useful appraisal tools and resources to assist you in creating your Cost Approach estimates. In this article, we’ll show you how you can save time and effort on your next Cost Approach appraisal using SwiftEstimator™ for ClickFORMS™.

Bringing it all together – The SwiftEstimator™ for ClickFORMS™ Solution

Now that you’ve seen the benefits of using the Cost Approach method, let’s look at how SwiftEstimator for ClickFORMS can help you quickly and easily create your own Cost Approach appraisal. The key feature of the SwiftEstimator for ClickFORMS solution that eliminates the complexity of using the Cost Approach is the seamless integration of these two programs. Now, you can accurately verify market-based valuations, project construction costs, adjust estimates for unique physical property features and monitor real estate markets all from within the familiar and easy-to-use ClickFORMS environment.

Faster Cost Approach Appraisals - A Closer Look

SwiftEstimator for ClickFORMS streamlines the cost approach, allowing you to appraise property values in a fraction of the time, at a fraction of the cost. Creating standard, short, input listing and depreciation cost reports is easy using the SwiftEstimator™ online forms and intuitive user interface.

Additionally, Form 1007 for FHA and HUD appraisals for single-family and low-rise multi-family residences, townhouses and duplexes are easy to create and later adjust as new information becomes available. Let’s take a look at an example of how SwiftEstimator for ClickFORMS lets you create a Cost Approach estimate in just a few easy steps. From within ClickFORMS select Cost Analysis from the Services pull-down menu. »

Then click the Get Estimate button from within the dialog box that appears.

The general information of your estimate is automatically imported into SwiftEstimator from your ClickFORMS URAR form, saving you from manually having to enter this information.» Note: You can easily navigate the site by selecting the links in the left navigation bar. Click on Building Data in the left navigation bar and then select residence type, style, enter total floor area and choose quality of construction.

Now you can select Components.

The first time you create an estimate you will see an assumptions page that presents you with the standard components that appraisers use most often.

First select a System and then select a Component. Click the Select button to edit the component to specify the percentage or units for that component.

You can click the Definition button after selecting a component for more information about that component.

Finally, click the Add button when you have completed editing your component.

Repeat this process for each component you wish to add to your estimate.

Now you are ready to calculate the estimate. (This is the last step.) Simply click Reports/Calc on the left navigation bar and then click the Calculate to generate your report.

After you see your report, click the Transfer to ClickFORMS button to move your cost analysis information into a square foot appraisal form (1007) in ClickFORMS. You can even make modifications to your cost estimate for up to seven days.

As you might expect, many appraisers have greatly reduced their dependency on the costly and time-consuming process of manually creating estimates using the cost approach. In fact, many of our customers have cut their cost-per-appraisal by as much as a factor of ten.

Ensure Accuracy and Reliability

SwiftEstimator for ClickFORMS ensures that your cost approach estimates are always accurate and reliable. Based on Marshall and Swift’s industry cost data, you can create cost approach appraisals for your clients with the confidence that they are current and up-to-date.

Be sure to visit our website at www.bradfordsoftware.com. Or call us at 1-800-622-8727.
We’ll show you how SwiftEstimator for ClickFORMS can improve the accuracy and efficiency of your appraisals using the cost approach method – faster and more affordably than anyone else.