PRESS

COST APPROACH TALK OF APPRAISAL INDUSTRY:
The cost approach has been a quiet controversy in the valuation industry since the new Fannie Mae forms came into use a year ago this month.
(11/20/2006)

One of the major changes on the form was the elimination of the requirement for the appraiser to supply the cost approach to value.

If the appraiser deems it applicable and necessary to include the cost approach for a value conclusion, then, as per Fannie Mae guidelines, the cost approach should be included. Otherwise it is not considered necessary.

In order to have a better understanding of the issues that affect both their appraiser and lender clients, BlueBook International took the opportunity to team up with Strategic Development Worldwide, sponsoring a specifically focused industry survey on cost approach issues, according to Vicky Cassens Zillioux, managing director of Strategic Development Worldwide.

Appraisers, lenders, appraisal management companies and other industry leaders were included in the survey, according to Cassens Zillioux.

“In the months preceding the release of the new forms, there were various courses offered to the appraisal community with regard to changes in the forms and the new guidelines surrounding them,” she said. “Some appraisers came away with the opinion that they had always included the cost approach and would continue to do so. Others felt that this brought an opportunity to save time in their process and they were not going to supply a cost approach unless they felt it was necessary for a credible report. Still others felt that they would supply it only when their lender client needed it.”

That was just the beginning of the confusion.

To do or not to do
Appraisers found that their clients, more frequently mortgage brokers than lenders, were not aware of whether they needed the cost approach or not.

“Then the issue that came to the forefront was that when lenders were requesting it, they were not looking for a cost approach to further substantiate value — they were looking for a number to use for insurance purposes so that the homeowner hazard insurance would cover the mortgage in case of loss,” according to Cassens Zillioux. “That revelation then brought up the issue of liability and what additional responsibilities the appraiser was taking on, intended users’ discussions and the use of disclaimers in the appraisal. No one seems to be getting what they need in the confusion.”

Overall, the survey responses indicated that the cost approach should not be eliminated when it can be done accurately and when its use is appropriate. However, the lenders interviewed held the opinion that the cost approach is typically not performed correctly and therefore is not valid most of the time.

Sylvia San Nicolas, senior corporate strategist and general counsel for Bluebook International, said the goal of the survey is to create awareness among the lending community regarding the cost approach.

Is it right?
“The lending community has been relying on something it shouldn’t rely on,” she said. “They should leave the appraisers alone and do their own due diligence.”

The issues included the following:

Many appraisers are not well-versed in using the cost manuals or online options that are available to them; depreciation is difficult to calculate, particularly in older homes, and the untrained appraiser does not understand the concepts and methodology;
“Cost to replace new” calculations are not accurate on a local level and appraisers may not take the time to investigate what local building costs are in their market; and
Land sales are frequently not available.

“It is a general industry consensus that the combination of the issues listed above tend to make the cost approach unreliable,” Cassens Zillioux said. “This general consensus creates an attitude many appraisers have that the cost approach is unimportant and doesn’t merit the time and energy to do it right.”

The indifference to the information supplied, as long as the numbers tally well with the market approach, is well known and many professional appraisers have reacted accordingly, according to the survey.

While most appraisers subscribe to a cost manual service, some of these services require specific training to understand how to utilize the information.

The survey also noted that some appraisers include a statement in their appraisal that they have used the cost manual service but in reality are plugging in numbers that ‘work’ to conform to the market approach adjusted values.

A question of accuracy
There is also underlying opinion in the market that cost services do not always supply accurate information, particularly on a local basis.

“Those lenders that understand the cost manuals (particularly when the decision is driven by the chief appraiser in a lending organization) much prefer that the appraiser use a cost service and become well trained in its use and how it applies to their local market,” Cassens Zillioux added.

Because the lenders recognize there is frequently a lack of land sale information, some are willing to accept just a replacement cost new for the property being appraised, rather than requiring the appraiser to provide an educated guess as to the value of the land.

The intended user issue that comes along with the discussion of the cost approach and its use for insurance purposes is also without clarification.

Most lenders believe that there is potential risk to all parties because of the assumed inaccuracy of the cost approach. However, the definition of intended user varies quite a bit between the different parties, according to the survey.

“Lenders typically are of the opinion that the intended user is anyone in the mortgage process from the origination group through to the portfolio purchaser,” Cassens Zillioux added. “The majority of appraisers do not consider the insurance company to be included as an intended user. Lenders’ opinions varied.”

Chief appraisers in the loop
Cassens Zillioux also noted it would appear that the chief appraisers typically have a good appreciation for the issues at hand with regard to reliance on the cost approach for insurance purposes, but not all in that position have the authority to override the operational procedures.

While appraisers have been including a disclaimer about the cost approach and its use for purposes other than value support, lenders do not appear to have altered their practices.

However, down the line, with the secondary market group which in turn purchases the portfolios, the opinions seem to take a stronger stance.

Many of the larger portfolio purchasers have included statements in their documented requirements that they expect the lender to obtain the insurance amounts from the insurance company directly, as it is their responsibility to determine the correct amount of coverage at the time the loan is placed.

“This is a substantiated portfolio requirement and the expectation of the purchaser is that this requirement is being met,” Cassens Zillioux said.

Due to their documented requirements, those larger portfolio purchasers would hold the lender responsible for any related losses.

So what are the solutions to the dilemma?

Identifying the problem
According to Strategic Development Worldwide, it wasn’t readily apparent that there was a dilemma until the company started asking questions.

Appraisers are trying all kinds of approaches to cover client needs without incurring additional responsibilities that are not intended to be taken on in the appraisal process.

While some appraisers have attempted to provide a product at an additional charge, it frequently comes across to the client that they are being charged for a cost approach that they previously got at no additional expense.”

Many lenders and secondary market participants that responded to the recent survey indicated a substantiated report that gave them accurate local cost information applied to the specifics of the subject property would be of interest to them.

“This is different than what they feel they are getting from a cost approach today and they see the extra value in the detailed and substantiated information that can serve as a solution for what they are having difficulty getting from the insurer,” she said. “Quite possibly, this is not something that can be easily solved by the appraiser or the lender, but requires a knowledgably vendor to step in and supply a well researched solution.”

The view from the top
Exactly how the changes will impact appraisers just might be a matter of perspective.

Michael A. Pace, SRA, an appraiser from Cape Coral, Fla., said because his company is in an area of growth in the Sunshine State, appraisers there supply the cost approach on every report.

“We consider it relevant on almost every appraisal, so we have not eliminated it,” he said. “Several of our lenders also indicated they wanted the cost approach on our reports.”

Pace also added Fannie Mae’s new guidelines haven’t affected his company at all.

“Personally, I could care less what Fannie Mae requires, as it is my appraisal based on what is necessary for a credible appraisal according to USPAP,” he said.