Cost Approach Says Higher; Market Says Lower
You are appraising a newly built 2,400-square-foot two-story house on a 0.25-acre lot in a subdivision. The cost manual shows $185 per square foot replacement cost new, including contractor overhead and profit but excluding the site. Site value is $95,000; physical deterioration is $8,000; functional obsolescence is $0. Four closed sales adjust to $438,000, $444,000, $449,000, and $452,000. The contract price is $459,000, which includes $8,000 in seller-paid closing costs. The cost approach computes to $444,000 plus $95,000 minus $8,000, or $531,000. The lender wants a purchase-money opinion and asks why the approaches differ by about $80,000.
1. Compute the cost approach and identify the likely causes of the gap with the sales comparison approach.
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Replacement cost new is 2,400 x $185 = $444,000. Add site value of $95,000 gives $539,000; subtract $8,000 deterioration gives $531,000. The roughly $80,000 gap is too large to treat as ordinary depreciation. Likely causes include: the cost manual may reflect above-standard finishes or current builder costs not matched by the comparables; site value may be overstated or may already include some development costs; entrepreneurial incentive may be missing or double-counted; and the subdivision may be absorbing below replacement cost in a soft market. I would verify the cost figure against the builder's actual contract and check whether land sales support $95,000. The cost approach is useful as a feasibility check, but it is not automatically equal to market value.
2. How should you reconcile the approaches for a purchase-money appraisal?
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I would weight the sales comparison approach heavily because the subject is a new house in an active subdivision with four recent closed sales of similar homes. Those sales directly reflect buyer behavior, including any builder concessions. The cost approach is secondary and should be reconciled, not averaged. The gap suggests either the cost data or site value is not market-derived, or the market is not supporting replacement cost. I would not adjust the sales comparison upward merely to satisfy the cost approach. A reasonable reconciled value is near the upper end of the adjusted sales range, approximately $450,000 to $452,000, before the concession adjustment. If the cost approach remains unreliable after verification, I would explain its limited weight rather than force it into the final conclusion.
3. How should the $8,000 seller-paid closing cost affect your value conclusion?
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A seller-paid closing cost is a concession that may affect the net price paid by the buyer. I would first determine whether the concession is typical in this market and whether it was already reflected in the comparable sales. If the concession is common and the comparables also include similar concessions, no separate adjustment may be needed. If the subject contract is an outlier, I would analyze the net contract price: $459,000 minus $8,000 equals $451,000. That net figure is within the adjusted sales range and supports a value near $451,000. I would disclose the concession, state whether it affected the negotiated price, and avoid double-counting it by adjusting both the contract and the comparables. The final value should reflect the market's treatment of concessions, not merely the gross contract price.