Understanding Appraisal Approaches

Contact: Curtis Milton
Director, Single Family Finance
(202) 266-8597

Cost Approach Best Reflects Rising Material Costs

The appraisal process is a critical step in the home-buying process to ensure the accurate valuation of a home. In new home construction, it is particularly important the appraiser account for and appropriately balance the cost of materials used to construct the home with its current market value. To do this, appraisers can incorporate three approaches to determine the value of a property.

These approaches include:

  • the sales comparison,
  • cost, and
  • income method.

Under the cost approach, the appraiser estimates what it would cost to rebuild or construct an equivalent structure. Because this component of property valuation considers the costs of materials used to construct the property, it is often very helpful and necessary in accurately assessing the value of a newly constructed home.

Cost-based Appraisal Process Infograph

Builders Encouraged to Engage Appraisers Throughout the Process

It is also important that builders understand that it is acceptable, and extremely important, for a home builder to speak with an appraiser and provide all the information the appraiser needs to perform an accurate assessment of value. One item that has proven effective in assisting appraisers in considering material costs in developing new home valuations is an “appraisal binder.”

An appraisal binder — which is given to the appraiser upon his or her arrival to the property — will provide the appraiser with a cost breakdown of all materials used in the construction of the home. This information will assist the appraiser in balancing the market value of the home versus what it cost the builder in materials to construct the home.

Keep in mind that the cost approach to value is always used in combination with the sales comparison approach — with greater weight or emphasis given to the sales comparison approach, per Fannie Mae and Freddie Mac guidelines. Builders should also incorporate existing home sales as comparables if there is a lack of new construction comps that can be used.

In a recent listening session with Federal Housing Finance Agency (FHFA), NAHB suggested that more “weight” or consideration be given to the cost approach to value new homes, particularly in rural areas where there may be few comps or sales to help produce a fair and accurate assessment of value.