Real Estate Appraiser
01-26-2006, 05:54 PM
Cost approach
The Cost approach is sometimes called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. It is the land value, plus the cost to reconstruct any improvements, less the depreciation on those improvements. The value of the improvements is sometimes abbreviated to RCNLD—reproduction cost new less depreciation, or replacement cost new less deprecation. Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials.
In most instances, when the cost approach is involved, the overall methodology used is a hybrid of the cost and market data approaches. For instance, while the cost to construct a building can be determined by adding the labor and materials costs together, land values and depreciation must be derived from an analysis of the market data. This approach is typically most reliable when used on newer structures, but the method tends to become less reliable as properties grow older.
Observe that as the Cost Approach has non-market based components (costs), the approach may not be a good indicator of market value, even when new. This is most noticable on properties where the market demand is limited. Say for example a military base. The cost to produce the base is not indicative of its market value, even when new. In the US, the government is the only party that would be willing to "buy" this product. This immediate "loss" is a form of obsolescence.
Also observe that this includes "home improvements" that do not recover their costs in the market. A common example in California is the cost of a pool. In most houses, the cost to build a pool is far greater than the increase in market value to the house. This immediate "loss" is again, a form of obsolescence. Accurately determining obsolescence and depreciation (as the property ages) are usually the main problems within the Cost Approach to opine market value.
The Cost approach is sometimes called the summation approach. The theory is that the value of a property can be estimated by summing the land value and the depreciated value of any improvements. It is the land value, plus the cost to reconstruct any improvements, less the depreciation on those improvements. The value of the improvements is sometimes abbreviated to RCNLD—reproduction cost new less depreciation, or replacement cost new less deprecation. Reproduction refers to reproducing an exact replica. Replacement cost refers to the cost of building a house or other improvement which has the same utility, but using modern design, workmanship and materials.
In most instances, when the cost approach is involved, the overall methodology used is a hybrid of the cost and market data approaches. For instance, while the cost to construct a building can be determined by adding the labor and materials costs together, land values and depreciation must be derived from an analysis of the market data. This approach is typically most reliable when used on newer structures, but the method tends to become less reliable as properties grow older.
Observe that as the Cost Approach has non-market based components (costs), the approach may not be a good indicator of market value, even when new. This is most noticable on properties where the market demand is limited. Say for example a military base. The cost to produce the base is not indicative of its market value, even when new. In the US, the government is the only party that would be willing to "buy" this product. This immediate "loss" is a form of obsolescence.
Also observe that this includes "home improvements" that do not recover their costs in the market. A common example in California is the cost of a pool. In most houses, the cost to build a pool is far greater than the increase in market value to the house. This immediate "loss" is again, a form of obsolescence. Accurately determining obsolescence and depreciation (as the property ages) are usually the main problems within the Cost Approach to opine market value.