4-4 UNIQUE PROPERTY APPRAISALS
Appraisers are sometimes faced with unique properties: a log home, an extra small home, lower than normal ceiling heights, etc. Eligibility of these properties depends on whether or not the property is structurally sound and readily marketable. If a property meets these criteria, the appraiser estimates market value. However, depending on the uniqueness of a property, the final determination to accept or reject the property is made by the lending institution's underwriter. Excess land is another area in which to exercise caution. Land is considered to be excess if it is:
- Larger than what is typical in the neighborhood
- Capable of a separate use
- If there is excess land, describe it but do not value it. In this instance, the appraisal is based upon a hypothetical condition. A legal description of the portion being appraised is required.
4-5 COST APPROACH
The cost approach is an indication of value based on the premise that a buyer would not pay more for a property than the cost to construct a property of equal utility. The cost approach is not necessarily the best indication of market value for many properties, but it is often applicable for new(er) or proposed construction and special use properties. Such situations include the following for single family one- to four-unit dwellings:
Existing, less than one year
Existing, regardless of age
Market acceptability of cost as an indication of pricing and value
Unless the cost approach is deemed reliable on the above table or considered applicable in the appraiser's judgment, developing this approach is not required for a HUD/FHA appraisal. The reporting requirement of USPAP known as the departure rule does not apply because the appraiser must always use the cost approach to value when considered applicable.
Strict compliance with USPAP standards is required for all FHA appraisals.
- If the cost approach was excluded, report it in the reconciliation and insert the rationale for its exclusion.
A. COST APPROACH METHODOLOGY
1. Land Value Estimate
Standard Rule 1-3(b) of USPAP requires appraisers to "recognize that land is appraised as though vacant ...". The appraiser estimates the value of the land because it is generally considered to be a permanent, non-depreciating asset. There are exceptions to this generally agreed upon premise, but the exceptions will rarely be a factor in FHA/HUD related appraisals. Exceptions may include land with an erosion problem or a polluted property.
2. Excess Land
Excess Land is defined as the area by which the plot exceeds the area of a readily marketable real estate entity. This occurs when the subject lot is considerably larger than typical lots in the neighborhood and the excess is capable of separate use. Generally, the defining characteristic is an excess portion that can be subdivided and marketed as an individual parcel. However, in small communities and outlying areas, appraisers must use different criteria because the market may accept a wide variance in lot sizes. This segment of the market may show wide differences in lot use.
- If the plot contains excess land, delineate and appraise separately the readily marketable real estate entity and the existing or proposed improvements. Describe the excess land but do not appraise it with the primary 1 - 4 family residential building that is subject to a mortgage.
The lender will require that the value of excess land be excluded from the maximum mortgage amount that will be calculated only on a reasonable amount of land and improvements.
3. Sales Comparison Approach For Land Value
In areas with an active real estate market, the sales comparison approach is generally the primary method used. This method allows for collecting, verifying and analyzing recent and similar land sales to be compared with the subject land. Before a conclusion is reached, the comparable land sales are adjusted for differences between the sales and the subject property.
In areas with a significant lack of comparable sales to develop the sales comparison approach, use the Alsite method, which assumes a market-accepted ratio between land value and property value. Although the value estimate from this method is inherently less accurate than that of the sales comparison approach, it is still an acceptable approach.
- The appraiser must document, support and justify the chosen Alsite ratio.
Extraction is a method to deduct the depreciated contribution of the subject's improvement from the total sales price of the property. The remainder represents an estimate of land value. This approach is also inherently less accurate than the sales comparison approach.
- The appraiser must document, support and justify the estimate of the depreciated contribution of the improvements.
B. IMPROVEMENT COST ESTIMATE
Replacement cost is the preferred method for developing the Cost New of the subject improvements. Typically the appraiser uses the Replacement Cost New and quantifies all forms of depreciation, except obsolescence. An alternative is the reproduction cost. HUD does not require a specific method. The replacement cost of property is estimated to enable the application of the substitution principle. Estimates of the replacement/reproduction cost of property are not estimates of value, although they indicate the possibility that value, in an equivalent amount, may exist. Value depends entirely upon usefulness, not on the cost. Value tends to conform to cost, but this is not to imply that it is always equivalent to cost.
C. TYPICAL REPLACEMENT COST
The replacement cost estimate must reflect the costs typically found in an area - not necessarily the costs of a particular builder or owner. This method is typically preferred to the reproduction cost.
D. UNUSUAL AND NON-TYPICAL COSTS
Some of the items or allowances in the cost estimate may not represent equivalent value in a particular case. An owner might erect a house that would cost more than the houses that generally characterize the neighborhood, but the value of the home to the typical prospective owner in that neighborhood might be less than the replacement cost of the property. The cost of construction also may be in excess of value at a given time. Under some circumstances, a reduction in cost may be in prospect. If construction costs decline, value may also decline if it was originally equal to cost.
E. RECOMMENDED METHODOLOGIES
Generally, the Marshall and Swift square foot method is the most applicable method for estimating the Replacement Cost New. This is a simplified procedure and all appraisers must have the knowledge and skill to apply this methodology. This method may not be used for custom-built homes or unique buildings that require the segregated cost method. Typical residential construction with which HUD is involved should be rated "fair, " "average " or "good" quality. Mass produced, tract-built homes are rated either "fair" or "average, " meeting only the minimum construction requirements of lending institutions, mortgage insurance agencies and building codes. Appraisers must review the basic description to determine the correct construction type. The appraiser will complete the cost approach for each proposed construction case based on the construction type and quality rating of the property as shown in the Marshall and Swift Cost Handbook.
- Reference on the form the pages and revision date where the figures were obtained (usually two pages).
- Include a marketing expense with the replacement cost of improvements and an applicable current multipliers.
F. REMAINING ECONOMIC LIFE
Remaining economic life is an estimate of the remaining time period in which the improvements continue to contribute value to the property (building and improvements). The appraiser must consider the effect, if any, of modifications or renovations on the improvements. This effect is typically expressed in years.