cost approach - taptp.org – the texas association of property … · 2019-09-20 · techniques...

Cost Approach

Original Agenda – A Stroll Up the Avenue

TAPTP 1

• Introduction – The Rules (Tax Code & USPAP)

• Highest & Best Use

• Overview – Valuing Land

• Overview – Cost Approach

• Key Principles of Value – Cost Approach

• Life Concepts

• Analyzing Depreciation

• Age/Life

• Breakdown – Overview

• Depreciation by Extraction

Agenda - Revised

TAPTP 3

• Analyzing Depreciation

• Age/Life

• Breakdown – Overview

• The Hijack

• Depreciation by Extraction

TAPTP 4

Who can identify this superstar & his tag line?

Stewie Griffin

Auditions

Need Team Stewie Leaders for

Later in Presentation

TAPTP 6

Say WHAT – How To Training

The Rules

TAPTP 8

Value – Sec. 23.01 Appraisals Generally 1

b) The market value of property shall be determined bythe application of generally accepted appraisalmethods and techniques.

TAPTP 91 Texas Property Tax Code

If the appraisal district determines the appraised valueof a property using mass appraisal standards, themass appraisal standards must comply with theUniform Standards of Professional AppraisalPractice.

Value – Sec. 23.01 Appraisals Generally 1

The same or similar appraisal methods andtechniques shall be used in appraising the same orsimilar kinds of property.

TAPTP 101 Texas Property Tax Code

b) Continued

However, each property shall be appraised basedupon the individual characteristics that affect theproperty’s market value, and all available evidencethat is specific to the value of the property shall betaken into account in determining the property’smarket value.

USPAP 2018-2019

(d) Analyze the effect on value, if any, of the assemblage of the various parcels, divided interests, or component parts of

a property; the value of the whole must not be developed by adding together the individual values of the various parcels, interests, or component parts;

WHY?

TAPTP 11

Standards Rule 5-6

(a) value improved parcels by recognized methods or techniques based on the cost approach, the sales comparison approach, and the income approach;

USPAP 2018-2019

The WHY is CRITICAL

to understanding the Cost Approach & the Hijack!

TAPTP 12

YOU CAN’T MEASURE OBSOLESCENCE WITHOUT USING AN INCOME APPROACH OR

A SALES COMPARISON APPROACH

Reaction

Highest & Best Use

TAPTP 14

Highest & Best Use: Land As Vacant

• Land As Vacant

• For Market Value: Land ALWAYS valued as if vacant and capable of being developed to its highest and best use

TAPTP 15

• H&B Use Analysis = Economic Evaluation, but within context of 4 areas of consideration:

• Legally Permissible

• Physically Possible

• Economically Feasible

• Maximally Productive

Highest & Best Use: Land As Vacant

• Land As Vacant (Land Residual Analysis)

• Land is LAST agent of production allocated net productivity or value

TAPTP 16

Total Value As If Developed to Each Use

Less: Contribution of Labor, Capital, Management

Equals: Net Value to Land As Vacant

Use with Highest Land Value is H&B Use

17

Highest & Best Use As Improved

• Reverse the priority of receipts of net benefits

Value of Property As Improved

Less: Value of Land As Vacant (H&B Use)

Equals: Value of Existing Improvements(regardless of cost, age, quality, condition)

TAPTP

• IF Value of Land As Vacant exceeds value of property as improved, existing improvements constitute a detriment to the land in the amount of their demolition costs.

Highest & Best Use: Property As Improved

• IF Value of Land As Vacant exceeds value of property as improved:

TAPTP 18

Value of Land As Vacant (H&B Use)

Less: Demolition Cost of Existing Improvements

Equals: Value of Property As Is

Above is one of the two most common and most flagrant violations of proper valuation methodology in

property tax valuations.

Other? = Hijack

There are existing rules and regulations.

There are accepted valuation methodologies.

Does either result in compliance?

Not Necessarily!!!

Effectiveness of Rules & Regulations?

Effectiveness of Rules & Regulations?

Overview

Valuing Land

TAPTP 21

Appraisal Process

TAPTP 22

Land Valuation

• Sales Comparison Approach – most often used and recommended valuation technique

• Recent Sales of Comparable Tracts of Vacant Land or improved properties where improvements demolished

• If using improved properties where improvements were demolished by the BUYER AFTER the sale, use purchase price PLUS demolition cost as the land purchase price

Excess Land versus Surplus1

• Surplus Land

• Excess Land

TAPTP 231 The Appraisal of Real Estate, 14th Edition, Appraisal Institute

• Land not currently needed to support the existing use but cannot be separated from the property and sold off for another use.

• Does not have an independent highest and best use and may or may not contribute value to the improved parcel – and, almost certainly not at the same value/sf.

• Land not needed to serve or support the existing use

• Has potential to be sold separately and valued separately

• May have same or different highest and best use as existing use

Factors that Influence Value1

• Surplus Land 1

• Excess Land 1


Overview

Cost Approach

TAPTP 25

Cost Method

TAPTP 26

Sec. 23.011. Cost Method of Appraisal.

If the chief appraiser uses the cost method of appraisal to

determine the market value of real property, the chief appraiser

shall:

(1) use cost data obtained from generally accepted sources;

(2) make any appropriate adjustment for physical, functional, or

economic obsolescence;

(3) make available to the public on request cost data developed

and used by the chief appraiser as applied to all properties within

a property category and may charge a reasonable fee to the

public for the data;

Cost Method

TAPTP 27

Sec. 23.011. Cost Method of Appraisal

(5) make available to the property owner on request all

applicable market data that demonstrate the difference

between the replacement cost of the improvements to the

property and the depreciated value of the improvements.

Why?

(4) clearly state the reason for any variation between generally

accepted cost data and locally produced cost data if the data

vary by more than 10 percent; and



Cost Approach Procedure

• Land Valuation (preferably using Sales Comparison)

• Land ALWAYS valued

TAPTP 28

• Cost New of Primary Improvements

• Reproduction Cost: replica using same materials and methods as the subject property

• Replacement Cost: same use and utility, but using current, state-of-the-art materials and methods

as if vacant and available to be developed to its Highest and Best Use


• Develop estimate of depreciation from all sources

TAPTP 29

• Physical Deterioration: normal deterioration and decay

• Functional Obsolescence: loss in cost not due to physical deterioration that originates from within the property boundary

• External Obsolescence: loss in cost from forces or conditions external to the property boundary that have nothing to do with physical deterioration or functional (design) characteristics within the property boundaries


• Deduct depreciation from all sources in primary improvements from cost new of primary improvements

TAPTP 30

• Estimate contributory value of site improvements and/or secondary improvements not included in the primary improvements

• Add Land Value to depreciated cost of improvements to develop estimate of market value by cost approach

Cost Approach

Key Principles of Value

TAPTP 31

Cost Approach – Application & Key Principles

• Most applicable to newer properties and/or special purpose properties that are not typically bought and sold on the open market

TAPTP 32

• Principle of Substitution

• Buyer won’t pay more than cost of acquiring an equally desirable site and building a new facility

• Principle of Contribution

• Value measured in terms of how much an item contributes to the value of the whole property, not how much it costs

Cost Approach – Key Principles

TAPTP 33

• Externalities

• Real Estate has a fixed location. Two identical properties in different locations can have two very different values (even if land values identical).

• Consistent Use, Contribution

• Can’t add land valued to one highest and best use to the cost of improvements of another use without consideration of obsolescence

• Improvements have value only to the extent of the difference between total property value as improved and the land value as vacant and available to be developed to its highest and best use.

Life Concepts

TAPTP 34

Life Concepts

• Physical Life

• Useful Life

• Economic Life

TAPTP 35

• The total period improvements last or are expected to last; typically very long time

• The period of time over which a structure or component of a property may reasonably be expected to perform the function for which it was designed; also typically a very long time

• The period over which improvements to real estate contribute to total property value;

Life Concepts

• Actual (Chronological) Age

• Effective Age

TAPTP 36

• The number of years that have elapsed since construction of an improvement was completed

• The age of property that is based on the amount of observed deterioration and obsolescence it has sustained, which may be different from its chronological age

• Essentially, the age of properties like and with which a property is in competition in the market

Life Concepts

• Effective Age

• Can be older than chronological age if the property has been poorly maintained which can sometimes be cured through rehabilitation and/or renovation

• Can be new than chronological age if the property has been properly maintained and renovated to more current levels of quality, materials, amenities, etc. that advance the property’s competitive level to that of newer properties

TAPTP 37

Analyzing Depreciation

Age / Life Method

TAPTP 38

Economic Age-Life Method of Depreciation

TAPTP 39

Effective AgeEffective Age + Remaining Economic Life

• Permits consideration of changing markets conditions on Remaining Economic Life apart from property age and condition

• Permits consideration of condition and impacts of poor maintenance or, conversely, rehabilitation and/or renovation/modernization on Effective Age

Methods to Develop Depreciation

• Economic Age-Life Method

• Easy for clients and appraisers to understand

TAPTP 40

• Apply to the entire property, but less accurate if properties exhibit obsolescence

• Harder to distinguish between and consider depreciation in short-lived versus long-lived components

• Between Market Extraction and Economic Age-Life, Market Extraction is the better alternative

Analyzing Depreciation

Breakdown Method

TAPTP 41

Overview: Breakdown Method of Depreciation1


Overview: Breakdown Method of Depreciation

TAPTP 43

• Most accurate, but also most time consuming

• Requires extensive knowledge of appraisal and all approaches to value PLUS extensive income and/or sales market data;

• Included to provide overview knowledge of potential issues you may see in properties, but does NOT mean that you are expected to be able to implement breakdown method;

• Recommend you bring depreciation issues to a senior appraiser to help address


TAPTP 44

• Physical Deterioration - CURABLE

• Broken or worn out items that need to be repaired or replaced immediately

• Often referred to as: Deferred Maintenance

• Measure of depreciation: Cost to Cure


TAPTP 45

• Physical Deterioration – INCURABLE SHORT-LIVED

• Items that are economically viable to replace and typically replaced over the economic life of the improvements to maintain competitiveness and extend economic life

Curable, just not at end of life

Examples: Flooring, Painting, Roofs, HVAC

• Measure of depreciation:

Cost to Cure times Age/Life Ratio


TAPTP 46

• Physical Deterioration – INCURABLE LONG-LIVED

• Items that are not economical viable or physically possible to replace

Examples: Structural Components


Cost New times Age/Useful Life Ratio


TAPTP 47

• Functional Obsolescence – Curable

• Caused by a Deficiency – NOT Requiring a New Capital Addition

• Essentially a design or other deficiency that can be cured by changing what exists without adding a new capital addition

• Replace countertops or bathroom tiles with more modern items

• Measure of depreciation: Cost to Cure


TAPTP 48


• Caused by a Deficiency – Requiring a New Capital Addition

• Essentially a design or other deficiency that can be cured, but requires adding a capital addition that does not currently exist; Example: Additional Bathroom

• Measure of deprecation: EXCESS Cost to Cure (i.e. cost of adding to existing structure versus cost to add as part of new construction) OR Cost to Cure LESS Value enhancement


TAPTP 49


• Caused by a Super Adequacy (Excess) –Existing improvement that exceeds market requirements where cost exceeds value

• Cure is removal or redesign; curable where the cost to cure is offset by the value added or retained (i.e. usually through reduced operating costs or higher net income resulting from the cure)


• Cost New of Excess Less Any Physical Depreciation Already Taken Against Excess

• Plus the Cost to Cure


TAPTP 50

• Functional Obsolescence – Incurable

• Caused by Deficiency

• Example: Warehouse with lower usable ceiling heights than demanded by market

• Measure of Depreciation

Capitalized value of the net income loss

due to the deficiency

or

the value of such loss as measured using Sales Comparison, Paired Analysis


TAPTP 51

• Functional Obsolescence – Incurable

• Caused by Super Adequacy (Excess)

• Office Building with Excessively Wide Halls OR Office parking garage with excess size

• Measure of Depreciation

Cost New of the Excess

LESS Any Depreciation Already Charged

Against the Excess

PLUS

Capitalized Value of Cost to Carry the Excess


TAPTP 52

• External Obsolescence

• Temporary

• Example: Over-supply of office space expected to return to normal supply/demand relationship in 3-4 years

• Permanent

• Example: New freeway and developments on other side of town resulting in lower demand, lower values in subject property area


TAPTP 53

• External Obsolescence

• Temporary

• Measure of depreciation: Present value of the net income loss over the period the situation exists

• Permanent

• Measure of deprecation: Capitalized value of the net income loss or the value loss as measured by paired analysis of properties with/without the external influence

Pitfalls to Avoid in Breakdown Method

TAPTP 54

• False Depreciation: depreciating something that is NOT included in the cost new estimate

• Example: Using reproduction cost of 4 bedroom, 1 bath house, but depreciating the total cost to add a 2nd

bath to cure a deficiency

• Double Depreciation: depreciating a dollar or portion of a dollar of cost more than once

• Including carpet replacement in curable physical, but then also applying incurable physical to total cost new including carpet; always apply depreciation to $ not yet depreciated, not cost new.


TAPTP 55

• Most accurate method, but also most time consuming and requires extensive knowledge of appraisal and all approaches to value; also requires extensive data.

• You are NOT expected to be able to implement breakdown method at this point. Get help.

• Key Takeaway:



Feeling Overloaded?

TAPTP 56

Picked the Wrong Day!

The Hijack

TAPTP 58

Cost Approach – Hijacked

Examples: CAD Neighborhood/Economic Factors

TAPTP 60

In above example, McLennan CAD is multiplying

depreciated cost of improvements by 1.24 to 1.66 times.

Where is that economic factor step defined?

Team Stewie 1

TAPTP 61


TAPTP 62

Where is that economic adjustment step defined?

Llano CAD: 1.89 x Depreciated Cost on Main Imp

Result: Depreciated Cost = $1,249,180Cost New of Improvements = $1,161,150

Team Stewie 2

TAPTP 63


TAPTP 64

Where is that neighborhood adjustment step defined?

2.60 x Depreciated Cost $291,326 = $757,448

Travis

Neighborhood

Factor

Team Stewie 3

TAPTP 65


Cost Approach =

Cost New of Imp - Depreciation + Land Value

TAPTP 66

The Neighborhood/Economic Factor techniques being used by appraisal districts violate approved

valuation methodologies as defined in

The Appraisal of Real Estate,

Texas Property Tax Code and

Uniform Standards of

Professional Appraisal Practice.

IAAO

InternationalAssociation

ofAssessing

Officers

TAPTP 67

Definitions – IAAO Glossary

TAPTP 68

IAAO Modeling Standards 2018

TAPTP 69

A.1 Cost Approach

The cost approach is an indirect method of arriving atmarket value, based upon specification of replacementcost new less depreciation plus market derivedland value. The cost approach is calibrated byreview of construction costs and sales.

This approach produces more acceptable resultsfor newer properties, specialized properties, andproperties with insufficient sales. Modelspecification for the cost approach requires estimationof separate land and building values.

Customary Cost Approach Using IAAO Variables

TAPTP 70

MV = [(1 – BQD) x RCN] + LV

MV = Market Value

BQD = Depreciation (Bldg Qualitative Variable)

RCN = Replacement/Reproduction Cost New

LV = Land Value

Market Value = [%Good x Cost New] + Land Value

Market Value = [Improvement Value] + Land Value


TAPTP 71

MV = πGQ1 x [(1 – BQD) x RCN + LV]

MV = Market Value

πGQ = Qualitative Variables (location,

economic adjust, and time of sale)

BQD = Depreciation (Bldg Qualitative Variable)

RCN = Replacement/Reproduction Cost New

LV = Land Value

1 ‘An Empirical Analysis of the Incidence of Location on Land and Building Values’; Robert J Gloudemans, 2002


TAPTP 72

MV = πGQ x [(1 – BQD) x RCN + LV]

πGQ = Qualitative Variable

times

[(1 – BQD) x RCN + LV]

QV x [(%Good x Cost New) + LV]

QV x [Imp Value + Land Value]

Definitions – IAAO Glossary

TAPTP 73

QV x [Imp Value + Land Value]

Really?

That Ain’t Right!

IAAO and CAD Neighborhood Factors

• Now you know to look for the neighborhood or economic factors being used by the CADs.

TAPTP 75

• Some CAD appraisers say that is to compensate for items (like entrepreneurial profit) not included in cost systems like Marshall Swift.

However, entrepreneurial profit is typically 10%, 15%, or maybe even 20% -- NOT the 100%, 200%, and 300% factors being used.

IAAO and CAD Neighborhood Factors

• Some CAD appraisers defend the practice as part of their ‘modeling’ technology and state the adjustments are based upon their studies comparing depreciated cost to sales.

TAPTP 76

• Have you ever seen the CAD studies supporting these factors? NO! And, I predict, you will have a tough time getting any such documentation.

• Remember: No such adjustments exist in USPAP, The Appraisal of Real Estate, or the Texas Property Tax Code

USPAP Standard 5

In developing a mass appraisal, an appraiser must:

5.1(a) be aware of, understand, and correctly employ those recognized methods and techniques necessary to produce a credible mass appraisal

TAPTP 77

5.4(b) employ recognized techniques for specifying valuation models; and

5.4(c) employ recognized techniques for calibrating mass appraisal models.

USPAP Standard 5

5.6(a) value improved parcels by recognized methods or techniques based on the cost approach, the sales comparison approach, and income approach;

TAPTP 78

USPAP Standard 6.2

h) “summarize and support the model specification(s) considered, data requirements, and the model(s) chosen;

TAPTP 79

Comment: The appraiser must provide sufficient information to enable the client and intended users to have confidence that the process and procedures used conform to accepted methods and result in credible value conclusions. In the case of mass appraisal for ad valorem taxation, stability and accuracy are important to the credibility of value opinions. The report must include a summary of the rationale for each model, the calibration techniques to be used, and the performance measures to be used.”

Now you know.

So, Who Ya Gonna Call?

TAPTP 80

Hint: Unfortunately, NOT the Comptroller


Reporting the Hijack


TAPTP 82

At this point, sadly, no one.

So, what do WE do?

Know & Use the Rules.

TAPTP 83

Make open records requests.

See if CAD applying same factor to all properties regardless of type,

age, condition in an area.

Get CAD basis of these adjustments and challenge application of those

factors.

Cost Method

TAPTP 84

Sec. 23.011. Cost Method of Appraisal

(5) make available to the property owner on request

all applicable market data that demonstrate the

difference between the replacement cost of the

improvements to the property and the depreciated

value of the improvements.

Why?



Over the longer term we, as an

organization, a plan to force CAD

practices into compliance with

the laws and regulations.

TAPTP 85

Yes, that probably means

Legislation.

We need to all pull together!

Team Effort – All Pulling Together

Depreciation Analysis

Properly Done

Extraction Method

TAPTP 88

TAPTP 89

Market Extraction of Depreciation

IAAO & Chief Appraisers want mass appraisal cost

approach techniques applicable to thousands of

properties.

The problem is that the qualitative multipliers are not

the solution because they do NOT follow prescribed

valuation methodologies and techniques.

What mass appraisal needs is to

recalibrate depreciation tables based

upon market evidence!

You Can’t Handle The Truth!


TAPTP 91

• Find Sales of Comparable Improved Properties

Similar age, utility, conditions, effective age

• Adjust each sale for transaction variables:

rights conveyed, financing, market conditions at time of sale

• Estimate land value under each sale (preferably using sales) and subtract land value from sales price adjusted for transaction terms to arrive at contributory value of all improvements.

• Estimate total cost new of improvements of properties that sold


TAPTP 92

• Cost New of Imps Less Value of Imps = Depreciation (all types from all sources)

• Separate Value of Primary & Secondary Imps

• Separate Deferred Maintenance & Short Term Incurable Physical Deterioration in Primary

• Convert Total Remaining Depreciation to Depreciation / Year


TAPTP 93

• Deduct Deferred Maintenance & Short Term Incurable Physical Deterioration in Subject Primary Imps

• Apply market depreciation abstracted from actual sales to subject Primary Imps

• Add value of Subject Secondary Imps

• Add Value of Subject Land As If Vacant and capable of being developed to its highest and best use.

That’s the proper methodology to extract depreciation from the market.

And, that’s the truth.

TAPTP 94

Questions

TAPTP 95

cost approach - taptp.org – the texas association of property … · 2019-09-20 · techniques...

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