Can the cost approach be used over the sales comparison approach since it’s higher?

sales comparison approach vs cost approachThis was a question I got asked today from a frustrated seller. She had called me to get my opinion of an appraisal that was done on her home that had appraised lower than the contract amount. I would like to share with you my answer to her as well as my thoughts on the cost approach to value and its relevance in an appraisal.

A little background is in order before we get into my response to her question. As I stated, she had just received a copy of the appraisal on her home which was under contract, and it had come up short of the contract price. She noted that the cost approach had come in very close to the contract amount but the sales comparison approach was much lower. She asked me why the cost approach couldn’t be given more emphasis in the appraisal since it was closer to the contract price.

The cost approach is one of the three approaches to value, along with the sales comparison and income approach, that an appraiser uses to estimate the value of a property. Unless a property is being rented, or is in a market with numerous rentals, the income approach does not provide a very reliable estimate of value. This leaves the cost approach and sales comparison approach as being the most commonly used approaches to value. The cost approach considers current construction costs while taking into consideration depreciation and then adds in the value of the land. This approach is typically more accurate on newer homes because it can be difficult to accurately estimate depreciation. The last approach to value considered is the well known sales comparison approach, where recent sales are compared to the home being appraised. After adjustments are made for value differences between the subject and sales a range of value is provided that the appraisers uses to reconcile a value estimate from the sales comparison approach.

After these two approaches to value are developed the appraiser must then determine which approach is the most appropriate for the subject. In the past several years an interesting scenario has developed where building costs have continued to rise and property values of existing homes have dropped due to the collapse of the real estate market. Large inventories of homes and an increase in foreclosures and short sales have driven prices down, widening the gap between the cost approach and the sales comparison approach. Sales statistics are showing that the market is in the process of recovering, however there can still be a significant difference between the cost and sales comparison approach to value.

The appraiser’s job is to determine which approach best reflects the market value of the home. Because a reasonable and well informed buyer will typically pick the least expensive alternative, the sales comparison approach is usually given the most emphasis in the final value reconciliation. This is why the cost approach cannot be given the most emphasis just because it is closer to the contract price. The approach that best reflects the actions and motivations of buyers in the market is the one that is given the most emphasis. So as you can see while the cost approach may be similar to the contract price the majority of home buyers will usually look at what other homes have sold for as well as what is available for sale and make an offer based on what they find. This would reflect the most accurate market value and the sales comparison approach would be given the most emphasis.

I hope my explanation has helped you understand how the appraiser would emphasize the sales comparison approach over the cost approach in their final opinion of value. If you have any further questions about how appraisers arrive at the appraisal value leave me a message below.

If you found value or entertainment in this post you can subscribe by email or RSS feed. Thanks for visiting.


  1. Great post, Tom. Your reasoning makes sense. New construction really stopped in the Sacramento area for several years as values plummeted. As values surged last year though, new construction re-emerged because it became profitable again for new homes to be built (mostly for builders who already owned the land though). There are many different layers of the market to know and interpret. It sounds like you were able to give the owner a very informed answer.

    • Thanks Ryan. Our market has not came back as fast as yours, however there is some new construction in pocket areas. It sounds like the cost approach and sales comparison approach are probably more in line in your market.

  2. Hi Tom, just a personal observation, the appraisal rules seem to work fairly well for normal track home properties, but when you get to custom homes of a log type the rules for both sales and construction cost are deplorably low. So low that the cost to build can be off more than $250,000 low!

    That is true in my case, three different appraisers ranged from $190,000 to $250,000 low on the cost to build. The sales comps were ridiculous, there just are not any even kinda comparables over the last several years.

    So we have sunk good money in our custom log home only to find ourselves robbed by appraisers to the tune of a quarter million. Needless to say that has caused a severe hardship financing by making our equity position appear non existent.

    I would like to be able to say something good about appraisers, but right now I’m more likely to put a load of rock salt in the next one I see posterior….

    • Sorry to hear of your predicament Mike. I’ll have to defend my appraiser brothers though by saying that it’s not there fault that there are no sales. I have found the same situation in my market because log homes just don’t sell much. People usually build them and never sell them. When I have had this type of assignment I explain this to the lender and tell them that I will have to search for comparable sales that occurred further back in time or are further away. While this is not ideal it is necessary if the bank wants all or some of the sales to be of log construction. Log homes are the perfect example of custom construction. Most of the time the cost to build is so much more than is reflected in what you can sell the home for on the open market, which is the value that the bank wants.

  3. As a buyer, when the cost approach comes out lower than the sales comp, it is reasonable to go by the cost approach? Thanks.

    • If accurate cost data has been used then what this tells me is that prices are such that it makes more sense to build than to buy existing construction. This could be caused by low inventory and increased demand. You also need to consider the time involved in new construction. Bottom line is that if the cost is lower then it is the most economically feasible thing to do and should be considered as a reasonable alternative.

Speak Your Mind


Sign up and get valuable content!

  • Get local real estate market data
  • Learn valuable information from a seasoned appraiser
  • Find out what adds value to your home

I respect your privacy. Your information stays with me.