Cost Approach Innovation

Appraisal Buzz was recently introduced to Brent Bowen, a Dallas area appraiser who has been proposing a completely different way of looking at the cost approach, particularly for residential appraisers. We were able to ask Brent a few questions about the topic:

Buzz: Tell our readers a little about yourself.

Brent:  I am a residential appraiser working in the northern suburbs of Dallas. I own a small appraisal company with a handful of excellent certified appraisers and a great support staff.  Appraisal has fascinated me since my introduction to it at Baylor University in 1996. The next year I graduated with a degree in Economics and Real Estate and moved to Dallas to begin my training to become an appraiser. Since then, I have become a real estate broker as well, but have never pursued that as a career.

Buzz: You say that innovation is needed for the cost approach. What made you come to that conclusion?

Brent:  There is nothing wrong with the cost approach. The principles and reasoning which underpin the cost approach to value are still sound. However, the existing, accepted methodology has been inadequate to achieve the stated goal. The cost approach is just that–an approach. The end goal is credible assignment results. If the assignment includes market value, then the existing methodology just doesn’t serve that end goal well, at least not in some markets.

Buzz:  What kind of markets are those?

Brent:  In markets where there is good access to data and active new construction, particularly in housing tracts, the existing methods for obtaining replacement costs are inadequate. It seems to me that they are reinventing the wheel, so to speak. In my opinion, the wheel that they produce makes for a very bumpy ride!

Buzz:  Are you referring to cost data services and cost manuals?

Brent:  Yes. Cost data services base their data on cost surveys which are then categorized and ranked. Then multipliers are applied in an attempt to make that data relevant to specified markets for a specified time period. When the subject property does not neatly fit into one of only a few categories, the margin for error increases further. Even without error, the end result comes with a disclaimer. Basically, the estimated replacement cost does not account for economies of scale, which can be considerable for construction in housing tracts. It is up to the appraiser to utilize local market data in order to take that type of difference into consideration by revising the cost estimate.

Buzz:  What sort of innovation are you suggesting?

Brent:  The primary difference in methodology that I am suggesting is to extract cost data directly from the market. When a new construction sale occurs, the cost of the improvements can be extracted from the price. This cost therefore implicitly includes not only local costs for labor and materials, but also economies of scale, overhead, and profit which were actually captured in the market. When multiple sales are extracted, the appraiser can develop a pool of data which is much better suited to the actual purpose of the cost approach as a means to developing an opinion of market value.

Buzz:  Are you describing something more theoretical in nature, or is the something that any appraiser can put into practice?

Brent:  This is very practical. Over the past couple of years I have experimented with this quite a bit. In practice, I have been able to extract sufficient data to make some very accurate predictions of the “most probable sales price” which is the heart of the definition of market value.  I have tested this many times on new construction properties. I will take a new construction property where the sales comparison approach was an accurate predictor of the sales price, and then apply the cost approach using various cost services and my method. In 100% of my case studies, my methodology resulted in a cost approach which was more consistent with the indicated value of the sales comparison approach and the actual sales price of the property. Nothing is required that most appraisers do not already have and regularly use in their practice.  A simple spreadsheet program is all that is needed. I have built a couple of different versions to test some different extraction techniques. I am no computer genius, so if I can do it, then I am confident that any appraiser in the right kind of market can do this.

Buzz:  How can our readers find out more about this method?

Brent:  I have written an article for an upcoming issue of Appraisal Buzz which goes into quite a bit more detail.  I originally had intended this for training within my office, but I am glad to have the opportunity to share it with a larger audience. I am also attending the Valuation Expo in Las Vegas from October 2nd-4th this year and would love the opportunity to discuss this face-to-face with my peers as well.