Lenders: How Important is Replacement Costs in Underwriting/Appraisal in 2022? Seller refuses to move off it.
I have a seller that I approached to buy his off market apartment building (62 units). He has a report that indicates the replacement cost for his property is $10M. According to market cap rates this property should sell for near $8M.  Seller is a builder and constructed the property but will not move off his replacement cost figure.

I tried to explain to him that yes, replacement cost is certainly a factor in appraisal value but a bank is more worried about the cash the property throws off and its ability to service the debt vs how much it would cost to replace the building.

Is replacement costs being weighted more nowadays in the underwriting and appraisal process? Does he have a point? Should I rethink how I've been analyzing properties?
[{"id": "i2c7n0f", "text": "No, it's not important. \n\nReplacement cost is never developed as *this specific building* its a X sq ft at Y per foot with Z for land = RC. It usually doesn't even have comps in that section of the appraisal.\n\nYou said it's off market so your \"seller\" doesn't care about the market cap rate. This replacement cost speel sounds like cover for \"but I want more than that\"", "replies": [{"id": "i2c8rti", "text": "I didn't think so. These guys are builders but I don't think they have transacted much themselves.  They see that juicy replacement cost figure and I don't think they understand that no bank is going to loan off this figure.", "replies": [{"id": "i2c9xyd", "text": "It's not on the market. They aren't asking to sell, you're asking to buy and getting a \"make me sell it\" price not an actual market price.", "replies": [{"id": "i2ca9fz", "text": "Oddly enough the reason they had this study done for replacement cost is because they were prepping to go to market with a broker.  They definitely want to sell but feel like they are going to get their full replacement cost as their price. I think they're going to be sorely disappointed.", "replies": [{"id": "i2cdt1p", "text": "It doesn\u2019t matter if the replacement cost is more than market value as it\u2019s the number the seller wants. Just think of it as their bottom line if that\u2019s really what it is.\n\nEdit: and they may very well get that in this market. You can never tell.", "replies": [{"id": "i2ce4e7", "text": "As always, the market will decide what the property is worth but their operating statements and T12 figures suggest they will never get anywhere near replacement costs for their property.  I just wanted to make sure that I wasn't missing something with the way commercial MF is appraised or underwritten in 2022 re: replacement costs.", "replies": [{"id": "i2cgwmh", "text": "The market works collectively to establish the correct price on average. A single uninformed or reckless buyer can pay more than market value at any time.", "replies": [{"id": "i2chfbg", "text": "Anything is possible in this market. One desperate 1031 buyer trying to park money or somebody else ready to pay  sub 3 cap on a 60 unit building. Too rich for my blood.", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "i2dkja8", "text": "Lots of developers I know are building to get 1031's right now.", "replies": [{"id": "i2dnx61", "text": "Do you mean they are doing ground development with 1031 money or they are building ground up to attract 1031 buyers?", "replies": [{"id": "i2dqdiz", "text": "No. Their doing ground development looking for desperate 1031 buyers. If it's only happened once or twice in the last few weeks I'd probably have not noticed but after the fourth one last Thursday it made me think is this an upcoming strategy someone posted on bigger pockets or something?", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "i2fd37p", "text": "What is the cap rate on something like this ?", "replies": [{"id": "i2fo6w4", "text": "On their financials? 2.8", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "i2ch7kw", "text": "100% correct", "replies": [], "depth": 2}, {"id": "i2fzqn6", "text": "This. Replacement cost doesn't really matter if the project isn't economically feasible...\n\nAlthough if the sellers not interested in selling at that price then you either have to throw out your cap rates and buy at the price he wants to sell or you need to move to the next property.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i2c8fbg", "text": "Is this property a new development? Is it fully leased up?", "replies": [{"id": "i2c8mhf", "text": "Property built in 2014 and it's about 94% occupied. Still lots of bad debt though from COVID as it's very difficult to evict in our market.", "replies": [{"id": "i2ca14g", "text": "As a lender,  I would not expect an appraiser to use the cost approach, and would instead rely on the income approach and sales comp approach. \n\nUltimately, the appraised value of the property is what we lend off of (anywhere from 65-80% LTV depending on location, quality, and guarantor strength). A 1.20x DSCR is required as well.\n\nAs a lender, I\u2019m less concerned with how much it will cost to rebuild in the event it burned down, vs. what we can sell it for now if the borrower defaults. \n\nWhether or not the seller cares about any of this is a different story lol.", "replies": [{"id": "i2carus", "text": "Ok, so I'm not crazy with disregarding their wanting replacement cost as a price. This is a value add for me because I have a different model that is going to really juice the cash flow but that's value that I want to unlock and don't want to pay for up front.\n\nI'm hoping that their listing agent would have eventually talked some sense into them and brought them down to earth but sellers are going to do what sellers are going to do lol.", "replies": [], "depth": 4}, {"id": "i2ce2vo", "text": "The cost approach would still use depreciation, so even though it\u2019s not as representative as the income approach of market value, it\u2019s still not the replacement cost alone.", "replies": [{"id": "i2ceahx", "text": "Agreed, good point.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i2ccf6u", "text": "Replacement cost is a joke", "replies": [{"id": "i2ccid4", "text": "One more time for the MF sellers in the back!", "replies": [{"id": "i2ck4qj", "text": "\u201cPriced below replacement cost\u201d wow I can\u2019t believe this what a deal", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i2chgb9", "text": "As others have suggested, replacement cost is irrelevant to appraisal. The potential seller's price is just the amount they want irrespective of actual value, and they're quoting a 'replacement' number because that's all they have in support of their position. Base your valuation on income and sales approaches, then decide if you're willing to pay the difference between value and asking price or just move on.", "replies": [], "depth": 1}, {"id": "i2cidcu", "text": "Wouldn\u2019t replacement cost be more important for insurance discussions?", "replies": [{"id": "i2e24vp", "text": "100% but I wasn\u2019t sure if I was missing some new crazy ass COVID adjusted appraisal methodology I wasn\u2019t aware of in the market.", "replies": [{"id": "i2ebb0l", "text": "Yeah I think not - I\u2019m in commercial real estate lending and we look at appraisals all the time but we never look at replacement cost for either sizing loans or general analysis", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i2cijir", "text": "What market/ region of the US is this?  I'm surprised a MF would be pricing at a big discount to replacement cost.", "replies": [{"id": "i2ckro0", "text": "Mid-atlantic region. Tell me more about your thoughts on discount to replacement cost. I came here to get lots of opinions so I'd be interested to more about yours.", "replies": [{"id": "i2cmfhf", "text": "So if the market value of the property is at a discount to replacement cost, that means that development isn't economically feasible.  Is there something unique to this property that is causing it to suffer economic obsolescence? Given what's going on in the market, I'd generally think that replacement cost of a 2014 built apartment would be at least 20% below where the value from the DCF would shake out.", "replies": [{"id": "i2fphab", "text": "I think that it\u2019s a smaller property so not a lot of institutional interest plus while it is a newer building it lacks the amenities (pool, gym, club room, concierge) that other properties in the neighborhood posess and their rents reflect that.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i2cmzkh", "text": "Could he get $10MM if he lists it?", "replies": [{"id": "i2cn9er", "text": "Possibly? It'd be a sub 3 cap, which is not market, on his financials for a 60 unit building. Doesn't meet my personal criteria but I'm not under any 1031 deadline or otherwise looking to just park my cash returns be damned.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i2cnz32", "text": "*How Important is Replacement Costs in Underwriting/Appraisal in 2022?* \n\nTo the sellers, it's apparently pretty important.\n\n*Seller refuses to move off it.*\n\nDon't make an offer.", "replies": [{"id": "i2coe1c", "text": "Fair enough. I understand it is certainly important to the sellers but I was curious about how important it was to underwriters and appraisers.", "replies": [{"id": "i2cv4f7", "text": "Not at all.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "i2cv75x", "text": "Depending on the age/condition/quality of the improvement, the depreciated replacement cost new could very well be less than $8MM. But zero percent of market participants buy MFs based on replacement cost, so the appraisal will likely not even develop it. They will develop a land value to see if the HBU as improved exceeds the land value, but unless the scope of work includes it or you need the insurance value the appraisal likely won\u2019t use one. Long story short is that replacement cost is a non-factor in calculating investment value on MFs", "replies": [], "depth": 1}, {"id": "i2dgnxf", "text": "$161k per door? When was it built and where is it (roughly)?\n\nPeople are buying marginal apartment deals on non-recourse bridge loans. Cap rates, DCR and historical income be damned.\n\nNormally I'd say sellers need to get with the program. But with the insane amounts of capital in multifamily, it's the buyers who need to catch up in this seller's market. Or stay on the sidelines.\n\nIn terms of your deal, if it doesn't pencil for you, it doesn't pencil. Best not to get attached to any one property and \"SWSWSWSW\"...", "replies": [], "depth": 1}, {"id": "i2e62y6", "text": "In terms he can understand he is \"over capitalized\" as in IF that's how much it cost him to build, and I doubt that it did, then he spent too much building it. The reports replacement cost probably took place when material costs were inflating over the last couple of years of the pandemic. Sometimes those same reports might have a secondary valuation method which in this case should be cap rate. Explain to him that replacement cost is usually just for insurance purposes and it is no practical measure of market value because you can't sell the building for parts!", "replies": [], "depth": 1}, {"id": "i2fe3gp", "text": "\u201cMarket cap rate\u201d I LOL\u2019d.", "replies": [], "depth": 1}, {"id": "i2haemb", "text": "Try putting it in terms they are more used to. Ask if they would pay $[your area's premium sq ft cost] for a house just because that would be the replacement value in said swanky neighborhood, or if they would pay the built in 1983 price. You could use cars (brand new v 1 year off the lot), boats, whatever their interests are.", "replies": [], "depth": 1}]