Valuation of

cost(cost
approach)
Cost approach
1. The cost approach is a real estate valuation method that estimates the price a
buyer should pay for a piece of property is equal the cost to build an equivalent
building. In the cost approach, the property's value is equal to the cost of land,
plus total costs of construction, less depreciation. It yields the most accurate
market value for when a property is new than through alternative methods.

2. The cost approach is one of three valuation methods for real estate; the others
being the income approach and the comparable approach.
Understanding Cost Approach
1. Instead of focusing on the prices other, similar homes in the area are selling for,
or a property’s ability to generate income, the coast approach method values
real estate by calculating how much the building would cost today if it were
destroyed and needed to be replaced from start to finish. It also factors in how
much the land is worth and makes deductions for any loss in value, otherwise
known as its depreciation.

2. The logic behind the cost approach is that it makes little sense for buyers to pay
more for a property than what it would cost to build from scratch.
 01 Reproduction method: This version
There are two main considers what a replica of the property
types of cost would cost to be built and gives
attention to the use of original
approach materials.

appraisals:
02 Replacement method. In this case, it is
assumed that the new structure has the
same function but with newer materials,
utilizing current construction methods
and updated design
When all estimates have been gathered, the cost
approach is calculated in the following way:

cost – depreciation + land worth

= value of the property

First, the cost technique tends to be Second, the cost approach furnishes the best
favored for the appraisal of new evidence of value for properties having little
construction. If the building is marketability, namely, public buildings,
designed with typical building churches, and highly specialized industrial
features, workmanship, and materials, structures. While the cost technique is highly
there is usually a close approximation subjective, in these instances the
to new construction cost and appraiser has few
market value. The cost alternatives to guide
approach tends to lose accuracy for
building
benefits the market value
estimate.
showing substantial depreciation.

Third, the cost technique is appropriately used to

estimate the cost of building rehabilitation,
modernization, or remodeling. Here the capitalization
of net income and the market approach supplement the
cost approach to value.

Fourth, the cost approach tends to be reason-ably accurate if (1) the building shows a minimum of
depreciation and (2) the site is developed to, its highest and best use. The cost approach to value helps
in the decision-making process, for example, in comparing the projected cost of a new apartment
building with its capitalized net income value. On the other hand, it would be invalid to appraise a 30-
year-old single-family dwelling under the cost approach if a two-story walk-up apartment were believed
to be the highest and best use. Therefore, the cost technique is adapted to the valuation of new
property which shows little depreciation and represents the highest and best use of the site.
 The cost approach system has many limitations in practice. The method
assumes that the buyer could find the land to build an identical property and
that's not always the case. Higher cost of land on another lot might drive the
price up even if building costs are reasonable. Construction costs are another
vital factor. Would similar construction methods be used to build a new home
in the area to those of existing homes there - or would the construction be
functionally equivalent but with hidden expenses? One example of a building
cost would be the material used to build walls in a new home. Do plaster
walls have the same value as drywall in real world purchase prices?

Additionally, the local political or economic

environment might not be friendly to new
construction. The area could already be fully
developed. Local planning authorities might be
so restrictive that new construction is not worth
the trouble. Unfortunately, these factors aren't
considered in the cost approach.
Limitations Another consideration is that older
property can have major depreciation. It
might be difficult to accurately account
for this. What if a certain construction
material or method is no longer used?
Sometimes making adjustments for
depreciation is a challenging process.
The appraiser has room for a lot of
subjectivity.
 Special Use Properties
The cost approach is required and
sometimes is the only way to determine
the value of exclusive-use buildings,
such as libraries, schools or churches.
These resources generate little income
and are not often marketed, which
invalidates the income and comparable
approaches
When to Use the
Cost Approach
Insurance
Insurance appraisals tend to use the cost approach
when underwriting homeowners' policies or
considering claims because only the value of
improvements is insurable and land value is
separated from the total value of the property.
The choice between depreciated value and full
replacement or reproduction value is the
determining factor for the evaluation.
New Construction
The cost approach is often used for new
construction, too. Construction lenders require
cost approach appraisals because any market
value or income value is dependent upon project
standards and completion. Projects are
reappraised at various stages of construction to
enable the release of funds for the next stage of
completion.
Commercial Property
Finally, the cost approach is occasionally
relied on to value commercial property, such
as office buildings, retail stores, and hotels.
The income approach is the main method
used here, although a cost approach may be
implemented when design, construction,
functional utility or grade of materials
require individual adjustments.
STEPS IN THE COST APPROACH

1)Estimated LAND VALUE AS THOUGH VACANT AND AVAILABLE

TO BE PUT TO ITS HIGHEST AND BEST USE.

2) ESTIMATE the REPRODUCTION OR REPLACEMENT COST OF

STRUCTURES AS OF THE EFFECTIVE DATE OF THE APPRAISAL.

3) ESTIMATE the ACCRUED DEPRECIATION.

4) DEDUCT the DEPRECIATION FROM REPRODUCTION OR

REPLACEMENT COST.

5) ADD the DEPRECIATED REPRODUCTION OR REPLACEMENT

COST TO THE VALUE OF THE LAND.
 KEY TAKEAWAYS

The cost approach to real
estate valuation considers the
value should equal the total
cost to build an equivalent
structure.
The cost approach considers The cost approach is
the cost of land, plus costs of considered less reliable than
construction, less depreciation. other real estate valuation
methods, but can be useful in
certain cases such as when
evaluating new construction or
a unique home with few
comparable.
 Thank you

references
https://www.investopedia.com/terms/c/
cost-approach.asp
https://slideplayer.com/slide/5301390/
https://study.com/academy/lesson/cost-approach-to-p
roperty-valuation-definition-process.html

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