UNIVERSITI TUN

HUSSEIN ONN
MALAYSIA

ADVANCED REAL ESTATE VALUATION

BPE 1253

COST (CONTRACTOR) METHOD

 CONTENT
1. Introduction
2. Lack of Market Evidence
3. When to adopt Cost (Contractor’s)
method.
4. Approach to Estimating Costs.
5. conclusion
 UNIVERSITI TUN
HUSSEIN ONN
MALAYSIA

INTRODUCTION
 INTRODUCTION
 The valuation of a particular interest in land is
normally made by reference to its:
 Tenure
 Use
 Income-producing capacity

 When all factual information has been

collected, the details of recent sales or lettings
of similar types of property are analysed.
 The valuer is then able to make an informed
judgement about the market value.

 INTRODUCTION
The bases of the valuation methods:

Value Cost Profit

Based on: Based on: Based on:
Valuation of the property  Cost of  Profit from
 Capital value or Construction accounts
capitalised from a  Value on the  Value on the
rental income basis of cost basis of profits

Use: Use: Use:

 Comparison  Contractor’s  Profits method
method method
 Investment
method
 Residual method
 UNIVERSITI TUN
HUSSEIN ONN
MALAYSIA

LACK OF MARKET
EVIDENCE
 LACK OF MARKET EVIDENCE

 Not all valuation relate to market

transactions
 There are many instances of buildings or
interests where an opinion about its value
is required even though no market activity
has taken or will take place e.g:
 A rating assessment
 A compulsory purchase valuation
 LACK OF MARKET EVIDENCE

 Types of buildings and uses where holding

rarely change hands include:
 Public schools
 Local authority holdings
 Sewerage treatment works
 Power station
 Hospitals, church, mosque,
 Police station/fire station
 There is no likelihood that a capital or rental
value could be assigned to the building on the
basis of the analysis of comparable transactions.
 UNIVERSITI TUN
HUSSEIN ONN
MALAYSIA

WHEN TO ADOPT COST

(CONTRACTOR’S) METHOD
 When to adopt Cost
(Contractor) method
 The cost (contractor’s) method is a Cost-
Based Approach to valuation.
 The method is often considered as the
method of last resort where other
methods are inapplicable or impractical
(Scarrett, 1991)
 When to adopt Cost
(Contractor) method

No comparison:
due to their unique in nature and
character, these properties rarely change
hands and come onto the market
 UNIVERSITI TUN
HUSSEIN ONN
MALAYSIA

Approach to Estimating
Costs
 Concept of Cost
(contractor’s) method
The valuation is based on:

The cost of building

Less: (i) obsolescence
(ii) depreciation
Plus: the site value
Value of Property
 Approach to Estimating Costs
 No Market Comparison
 The approach recognises the value of the site for the
particular use,
 But, as there is no market then it is the cost of the
building that is taken into account.
 This produces a value for new building; older
building costs will be require an adjustment to
represent depreciation (the wearing out of the
building fabric) and obsolescence (inability of older
building to facilitate optimum performance, as
expected by current standards of design and
technology and the present-day economics of
location and use)
 Approach to Estimating Costs
 Building Cost
 Replacement building
 Similar appearance, footprint and height, although original
architectural embellishment would be excluded.
 The cost would be then be based on that of a broadly
identical building using modern building techniques and
materials insofar as they are compatible with the concept
of replacement
 Substituted building
 Normally be of modern design, taking account of any
advances in technique since the original was erected.
 E.g, 1-single storey may be regarded as a suitable
replacement for 3-storey original building with a row of
stabling replaced by car-parking provision
 Approach to Estimating Costs
 Cost estimates
 Elemental costs
 Material & labour costs
 Unit costs
 Approximate quantities
 Adjustments to building costs
 Depreciation
 Physical or economic obsolescence
 Functional obsolescence
 Technical obsolescence
 Market obsolescence
 Cost of Site
 Reference to the value of adjoining land.
 Example 1
(No market Comparison)

Replacement Cost
- Building size (100,000 sq.m @ RM200/psm)
= 20,000,000
Less: Obsolescence @50% = 10,000,000
Building Value = 10,000,000
Plus: Site Value estimated = 1,000,000
Value of property = 11,000,000

* Rate of depreciation/obsolescence is commonly in the range

of 10-60%
 Concept of Cost
(contractor’s) method
 Fire Insurance
 Assessment of reinstatement value of
premises in case of destruction by fire and
other perils.
 The valuation is the full reinstatement cost
and is determined on a basis of building cost
prevailing at the time of reinstatement.
 Example 2:
(Fire Insurance)
 An operational premises has just been completed by a public sector
body for its own use; it fulfiled the same purpose as an adjoining
building which is 50 years old. Value the older building.

Value of new building

Cost of land RM 500,000
Plus Cost of building RM2,000,000
Value on cost basis RM2,500,000
Value of older building
Cost of land RM 500,000
Less depreciation @ 50%
Depreciation cost RM 1,000,000
Value on cost basis RM1,500,000
Application of the Cost
(Contractor’s) Method
 Tutorial 1 :
A regional water board
 A major regional water board has recently
completed the building of operational
premises for its own use. The cost of the land
was RM500,000 and that of the building
RM3,000,000. The development is of the
same size and fulfils the same purpose as an
adjoining building erected 60 years ago. The
new building has been provided to cope with
additional demand. The original building will
continue in full operation.
 Using the contractor’s test, demonstrates the
separate approaches to valuation to the two
sets of premises.
 Tutorial 2:
A private hospital service in a converted house

 You act for the directors of a private hospital

service devoted to the treatment of patients
suffering from terminal illness.
 They occupy a large Georgian house in
extension grounds on the outskirts of a large
city. The original floor area has been doubled by
the addition of a series of single-storey
extensions over a period of years.
 You have received instruction to prepare an
asset valuation for incorporation into the annual
accounts.