The Cost Approach: To Do or Not To Do

The following is from a Liability Insurance Administrators' Claim Alert (May 2006): The growing pains of using the new Fannie Mae forms are continuing; an issue that has developed is whether appraisers should continue to complete the Cost Approach to Value, even in circumstances where it may not be reliable. The Cost Approach section is optional on the new Fannie Mae and Freddy Mac forms, while USPAP directs the appraiser to comment on all approaches to value – whether or not completed. Our national claims counsel suggests that you remind your lenders/clients about the intended use and intended user as defined in your appraisals. A particular concern is that your potential liability exposure may increase if the cost approach analysis contained in your appraisal is used for the purpose of obtaining insurance coverage or determining insurable value. An appraisal completed for a lender/client in connection with mortgage lending should not be used or relied on for insurance purposes. To address these issues and to complete the report in a manner that is not misleading, the following scenarios have been developed, with corresponding suggested language to add to your reports. 1. Appraiser believes the cost approach is applicable

The cost approach has only been developed by the appraiser as an analysis to support their opinion of the property`s market value. Use of this data, in whole or part, for other purposes is not intended by the appraiser. Nothing set forth in the appraisal should be relied upon for the purpose of determining the amount or type of insurance coverage to be placed on the subject property. The appraiser assumes no liability for and does not guarantee that any insurable value estimate inferred from this report will result in the subject property being fully insured for any loss that may be sustained. Further, the cost approach may not be a reliable indication of replacement or reproduction cost for any date other than the effective date of this appraisal due to changing costs of labor and materials and due to changing building codes and governmental regulations and requirements.

2. Cost approach required by client but appraiser does not consider it meaningful

At the request of the client, development of the cost approach has been attempted by the appraiser as an analysis to support their opinion of the property`s market value. Because there is insufficient market evidence to credibly support the (site value/ derivation of total appreciation), the cost approach is not given any consideration in the appraiser`s final analysis. Use of this data, in whole or in part, for other purposes is not intended by the appraiser. Nothing set forth in the appraisal should be relied upon for the purpose of determining the amount or type of insurance coverage to be placed on the subject property. The appraiser assumes no liability for and does not guarantee that any insurable value estimate inferred from this report will result in the subject property being fully insured for any loss that may be sustained. The appraiser recommends that an insurance professional be consulted. Further, the cost approach may not be a reliable indication of replacement or reproduction cost for any date other than the effective date of this appraisal due to changing costs of labor and materials and due to changing building codes and governmental regulations and requirements.

3. When client requires an Insurable Value Worksheet be completed by appraiser

Provision of an Insurable Value by the appraiser does not change the intended user or the intended purpose of the appraisal. The appraiser assumes no liability for the Insurable Value estimate provided and does not guarantee that any estimate or opinion will result in the subject property being fully insured for any possible loss that may be sustained. The appraiser recommends that an insurance professional be consulted. The Insurable Value estimate may not be a reliable indication of replacement or reproduction cost for any date other than the effective date of this appraisal due to changing costs of labor and materials and due to changing building codes and governmental regulations and requirements.

If your lender/client or an insurance company or agent would like to retain you to prepare an insurable value report, the company should specifically retain you for that purpose, and, of course, you should only accept such an assignment if you are comfortable preparing an insurable value report. An issue that may present itself is whether your client will reject inclusion of the above additional language in your report. Because Fannie Mae does not require the “Cost Approach to Value,” your client may not object to the language. However, if this dilemma presents itself, you may have to make a business decision to either decline the assignment or accept the additional exposure in order to maintain the client relationship. Copyright 2005. Liability Insurance Administrators. All rights reserved. Additional Resources:

• Liability Insurance Administrators Claim Alert Bulletins
• The Cost Approach - Appraiser Compliance Issues If you enjoyed this post, subscribe and get FREE updates! Appraisal , Real Estate , Appraiser , Scope of Work