Appraisal by the Cost Approach

That appraisal process which is based

upon the proposition that an informed
buyer would pay no more than the cost of
producing a substitute property with equal
utility as the subject property.
Economic Principles Underlying the
Cost Approach

• Contribution
• Substitution
• Highest and Best Use
• Supply
• Demand
Steps in Performing the Cost Approach
1. Inventory all improvements
2. Estimate cost to reproduce the basic improvement
3. Estimate cash amount of accrued depreciation due to
loss in value, physical deterioration, and obsolescence
4. Deduct the accrued depreciation
5. Estimate the present depreciated value of other
improvements
6. Add estimate of land value to the depreciated value of
improvements to get the value of the subject property
NOTE: For farm and ranch lands with minimum
improvements, you can start with land values and
class them by quality.
The Cost Approach Works Best for:

• New residences

• Specialty buildings

• Large commercial units

• When little market data are available

 Problems with the Cost Approach

1. Collecting data

2. Difficulty in estimating accrued

depreciation

3. The final estimate is usually too high

Important Terminology
1. Reconstruction Cost New (RCN)
2. Reproduction Cost
3. Replacement Cost
4. Depreciation (see slide)
5. Life and Age Concepts
• Useful life
• Economic life
• Remaining life
• Normal life
• Effective age
• Numerical age
 Discussion of Depreciation
Depreciation – Loss in value due to any cause

Physical – Deterioration due to weathering, wear, tear, etc.

Curable
Incurable

Functional – Obsolescence due to an impairment of

functional use.
Curable
Incurable

Economic (External) – Obsolescence due to external

Economic factors.
Incurable
 Examples of Improvements
1. Residences Others:
• Homes 1. Water Systems
• Apartments
2. Office Buildings
• Etc.
3. Commercial Factories
2. Utility Buildings 4. Shopping Centers
• Barns
•
5. Transportation Facilities
Sheds
• Airports
• Silo
• Ports
• Garages
• Railroads
• Storage
• Etc.
• Livestock housing
 Sample Using the Cost Approach
• Description of SP: brick-veneer house and lot in
Spruce Subdivision
• 1700 sq. ft.
• 3 bedrooms / 2 baths
• Fireplace
• 5 years old
• Normal life of home: 50 years
• Has a damaged roof which has a 20-year guarantee. It will
cost $4000 to replace it.

• Replacement Cost Factors:

• Replacement cost: $60 per sq. ft.
(established from area builders and contractors)
• Lots in Spruce Subdivision sell for $20,000
 Sample Using the Cost Approach (continued)

RCN = (1700 sq. ft.) ($60) = $102,000

PDC = (5/20) (4,000) = ($1,000)
PDI = (5/50) ($102,000) =($10,200)

PMV = $102,000 – ($1000 + $10,200)

PMV (house only) = $90,800

PMV (house & lot) = $90,800 + $20,000 = $110,800

 Ways to Estimate Reconstruction
Cost New (RCN)
Quantity Survey: This is a computation of all labor and
materials used to produce the improvements. Add to
this are the other contractor costs such as permits,
insurances, equipment rental, field office, supervision
and other overhead plus profit.
Unit in Place: This method employs unit costs for the
various building components by using some type of other
appropriate units of measurements.
Direct Comparison: This method derives “RCN”
estimation in terms of square feet, etc. based upon
known costs of similar structures adjusted for time and
physical differences, essentially a market comparision
approach.
 Methods to Measure Depreciation
Straight line method: The normal expected life of the improvement is
divided into the estimated current age, then multiplied by the RCN
value, i.e. Property Age divided by Normal Life times Reconstruction
Cost New.
Age
(RCN) = Depreciation
NL

Professional Observed Methods: This method requires an

experienced professional who can detect any losses in value by
visual inspection.
Sales Comparison Method: For this method, one can compare
various properties in the market to estimate losses in values due to
age, condition, etc.
Cost to Cure Method: This procedure uses market costs to estimate
the expenses incurred to restore a property to its original condition
or utility.