REPLICA PROGRAM – Underwriting Appraisal Reports
APPROACH TO VALUE
Approach to Cost
The real estate appraisal industry recognizes three (3) standard valuation approaches:
- Cost Approach
- Market Approach
- Income Approach
The Cost Approach
The logic behind the cost approach is that a prudent investor would pay no more for a property than the cost of replacement of a substitute property with the same utility as the subject. Therefore, if a property is new, the current cost of reproducing that equivalent tends to establish the cost of replacement, however, once the property ages, then the economic value of that property in the terms of a chattel demises.
The Direct Comparison (Market) Approach
In this approach, the value of a property is estimated through analysis of recent sales of comparable property. It is employed in the valuation of the property for which there is a known active market. This approach to value will not reflect an accurate limit for insuring to value.
The Income Approach
The Income Approach considers value in relation to the present worth of the future benefits derived from ownership and is usually measured through the capitalization of a specific level of income that a piece of the property or equipment can produce. This approach is most applicable to investment and general use properties where there is an established and identifiable rental market. This approach to value will not reflect an accurate limit for insuring to value.
Approach Selection
In any appraisal study, all three approaches to value must be considered, as one or more may be applicable to the subject property. In some situations, elements of two, or all three approaches may be combined to reach a value conclusion. For this appraisal, our primary emphasis in concluding an opinion of value would be placed on the Cost Approach. This approach being best suited to providing an estimate of the Replacement Cost New for insurance placement purposes, as insurance premiums are normally based on replacement cost and not market value. Therefore, the market and income approaches to value will not be presented in our report; it being concluded that they would not add to the validity or credibility of the appraisal.
SCOPE OF WORK
An insurance appraisal is a cost appraisal, that is, "the cost to replace or reproduce the property in like kind." Construction costs are broadly segregated into the direct and indirect costs associated with the assembly of the building. Cost estimates are developed through the examination of the direct and indirect costs associated with any facility. Direct costs represent the materials and labour necessary to construct and install the components of an operating facility. Indirect costs are the expenditures not directly associated with the facility construction and can include such items as architect fees, permits, consulting fees, or any other cost item not directly associated with the development of a building site. The sums of direct and indirect costs represent the total expenditures necessary to completely build a facility.
The cost approach begins with a cost estimate of the current construction materials, and labour required in assembling a building with the nearest construction utility to the subject property under appraisal.
Conceptually there is a difference between the terms reproduction cost and replacement cost. They are frequently used as synonymous terms, even within the appraisal profession and since there terms are so commonly used interchangeably it might be helpful to compare the concepts of reproduction and replacement.
Reproduction cost contemplates the reproducing of a building's design with identical construction materials and installation techniques and the replacement of building equipment with identical substitutes of the same operating capacity without regard for technological advances. The challenge in producing reproduction cost estimates increases with the age of a facility, for instance obsolete equipment may no longer be available, revisions to construction standards, and modifications to building codes and designs also present obstacles when estimating reproduction costs of older facilities.
The PRINCIPLE OF SUBSTITUTION is an economic principle stating that the price of a commodity tends to be no higher than the price of a substitute having equal utility, available without undue delay. This is the basis of the Replacement Cost approach to value, where the costs found in this report are obtained directly from the restoration construction publication market. No system, whatever its degree of sophistication or detail, can be better than the market-derived information on which it is based.
Replacement cost is the current cost to construct and install a substitute facility with the nearest equivalent utility in comparison to the subject property under appraisal. Replacement cost represents the cost of replacing the facility with a substitute facility capable of performing the same function recognizing the effects of technological changes as well as efficiency improvements. The replacement of the appraised facility with the most economical substitute facility uses modern construction materials, installation standards, and layout configuration without necessarily duplicating the size, flow or configuration of the appraised facility.
Estimates of replacement cost involve the consideration of improvements in materials, design features, layout and construction standards between the substitute facility and the subject facility. For instance replacement cost analysis identifies the availability of substitute materials and equipment for the various original facility materials and equipment. Replacement cost analysis also examines improvements in design standards and features as well as changes in construction standards. Materials and installation improvements are also an additional factor to consider when developing replacement cost estimates, particularly when an extended period of time has elapsed between the original construction of the facility under appraisal and the substitute facility.
In completing our analysis and estimate of the Replacement Cost New, a personal review of the data submitted and of current construction cost data was conducted by our team.
During the data collection phase we obtained information considered relevant in order to complete the appraisal assignment. Our mandate included a review of the architectural and/or construction components and building services associated with the property, the gathering and analysis of appropriate data and the costing of the collected data as included in this report.
In conjunction with the above, we have considered, as applicable the following factors:
- Size and degree of utility of the subject property
- Quality, type, and age of the subject property
- Current construction technology and building systems
- Current market prices for materials, labour contractor's overhead profit, and fees
- Current local and national applicable taxes
Within the cost approach there are three (3) distinct methods to develop costs:
- The Unit Method
- The Component Method
- The Model Method
THE METHOD OF REPRODUCTION
The Unit Price Method
In a unit price method the appraiser examines the plans for a structure or, if no plans are available develops a materials quantity list from field observations. This is known as the quantity take off. These quantities are then matched to the appropriate unit prices and the unit prices are extended by the quantities. Such costs can be calculated for any part of a construction project: materials, equipment, installation, and eventually total project costs including overhead and profit. The totals of all these costs are organized along a standard industry format that represents the total Unit Price Estimate. It is a generally accepted industry norm that estimates of this type have a plus or minus accuracy range of about (+1- 5) five percent. This is the most often method subscribed to if there is a small partial loss to the building (usually under $25,000) and is used in conjunction with a Damage Assessment Report (DAR).
The Assemblies Method
The assemblies approach to cost estimating involves the grouping of several units into components or assemblies. Essentially the assemblies' method reorganizes the unit price method into larger categories of building components. For example the many different unit price elements (concrete, rebar, forms, etc.) of a foundation are placed into a basic group and the cost of an entire foundation assembly is created. The same applies to floor, walls, roofs, and so on. It is a generally accepted industry norm that estimates of this type have a plus or minus accuracy range of about (+/- 10%) ten percent. Again this method is used in conjunction with a Damage Assessment Report (DAR) when the building has suffered a total loss or a large partial loss (over $25,000).
The Modeling Method
The modeling method develops the techniques used to determine construction cost of buildings based on certain criteria such as building occupancy, location, relative size, and general materials used. The modeling method allows an experienced appraiser to develop costs from building models contained within various publications and reporting agencies, as well as our own experiences with this type of property. It is a generally accepted industry norm that estimates of this type have a plus or minus accuracy range of about (+/- 15%) fifteen percent. For this type of appraisal, an Underwriting Appraisal Report (UAR) or a Loss Appraisal Report (LAR), we would utilize the "Modeling Method" to develop replacement costs new.
