An appraiser bases an adjustment for a comparable’s worn roof on the cost to replace it. What is the main limitation of this cost analysis?
Correct Answer
A) The cost may not equal the market’s reaction to the difference
Cost analysis is widely used for physical differences, but its shortcoming is that the adjustment is not market derived: the estimated cost may or may not equal market value. It is permitted, and it can understate or overstate the market’s reaction.
Why This Is the Correct Answer
Option A is correct because the shortcoming of cost analysis is that the adjustment is not market derived; estimated cost may or may not equal market value. Buyers may pay more or less than the replacement cost for a new roof. The method is permitted and widely used, but its results need to be checked against market behavior.
Why the Other Options Are Wrong
Option B: Cost data are not allowed in the sales comparison approach
Option B says cost data are not allowed in the sales comparison approach. That is wrong because cost analysis, including cost to cure and deferred maintenance estimates, is an accepted basis for adjustments, particularly for physical characteristics.
Option C: It can be used for location differences, not physical ones
Option C says cost can be used for location differences, not physical ones. This is backward: cost analysis is used particularly for physical characteristics such as a worn roof.
Option D: It overstates the adjustment that buyers would make
Option D says cost overstates the adjustment buyers would make. Cost does not reliably err in one direction; it may understate or overstate the market's reaction, which is why the real limitation is that it is not market derived.
Cost is not value
What it costs to fix is not necessarily what buyers will pay for the fix.
How to use: Use this when a question asks about the limitation of a cost-based adjustment.
Exam Tip
For cost-based adjustments, look for the answer about cost not necessarily matching the market's reaction rather than answers that ban cost data or assume a fixed direction of error.
Common Mistakes to Avoid
- -Thinking cost data are prohibited in the sales comparison approach
- -Assuming cost estimates equal the market's reaction
- -Assuming cost errs in only one direction
Concept Deep Dive
Analysis
This question tests the weakness of cost-based adjustments. Cost analysis is a common way to estimate adjustments for physical items like a roof. The key limitation is that cost is not the same thing as the market's reaction to the difference.
Background Knowledge
Cost indicators used for adjustments include replacement or reproduction cost less depreciation, cost to cure and deferred maintenance. These are convenient when paired sales are scarce. However, value is set by what buyers pay, which may differ from cost.
Real-World Application
A comparable sold with a worn roof that needs replacement. The appraiser checks local sales and finds buyers discounted similar homes by a different amount, so the appraiser reconciles the cost estimate with that market evidence.
More Sales Comparison Questions
Supported adjustments are: non-market financing $10,000, GLA $36/sf, garage $3,500 per car, pool/spa $12,500. A comparable identical to the 2,800 sf subject sold for $267,000 with non-market financing. What is its adjusted price?
Using GLA $36/sf and non-market financing $10,000: a 3,100 sf comparable sold for $277,000 with non-market financing; the subject has 2,800 sf. Bath count differences are not adjusted. What is the adjusted price?
Using garage $3,500 per car and pool/spa $12,500: a comparable with a 2-car garage and a pool/spa sold for $268,000. The subject has a 3-car garage and no pool. What is the adjusted price?
Using GLA $36/sf, garage $3,500 per car and pool/spa $12,500: a 2,600 sf comparable with a 2-car garage and a pool/spa sold for $264,000. The subject is 2,800 sf with a 3-car garage and no pool. What is the adjusted price?
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A house is a 4,000 square foot home in an area of 2,000 square foot homes. How must the appraiser treat this over-improvement in the sales comparison grid?
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