COST APPROACH
Definition
The Cost Approach is based on the principle that a buyer will not pay more for a property than the amount required to purchase the land and construct a substitute property of equal utility, less any depreciation.
A standard appraisal definition is:
The value indication derived by estimating the current cost to construct the improvements as of the effective date of the appraisal, deducting all forms of depreciation, and adding the market value of the land as if vacant and available for its highest and best use.
Standard Formula
The classic formula is:
Or stated another way:
Where:
- V = indicated value of the property
- L = land value as if vacant
- RCN = replacement cost new (or reproduction cost new)
- D = accrued depreciation
Key Components
1) Land Value
Estimate the site value as if vacant, usually by the sales comparison method using comparable land sales.
2) Cost New
This can be measured as:
-
Replacement Cost New
Cost to build a structure with equivalent utility using modern materials and standards -
Reproduction Cost New
Cost to build an exact duplicate of the existing improvements
Replacement cost is most common in market value appraisals.
3) Depreciation
Deduct all loss in value from:
-
Physical deterioration
wear and tear, age, deferred maintenance
- Functional obsolescence
outdated design, poor floor plan, excess improvements
- External (economic) obsolescence
adverse outside influences such as traffic decline, zoning, neighborhood issues
When Most Applicable
The Cost Approach is especially useful for:
- new construction
- special-purpose properties
- schools
- churches
- government buildings
- medical facilities
- insurance appraisals / replacement cost estimates
- properties with limited comparable sales
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