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Cost approach (cont) Value of the land determined first Cost for the building; – Reproduction; cost to construct an exact replica of the existing building – Replacement; cost to construct a building with the utility equivalent to the one being appraised; using modern material, current standards, design, layout, etc. Using either method use the date of the appraisal and with current prices

Data sources Local builders Market abstraction; based on sale of a new building after the land is subtracted; works best with houses, not so good with rural property Cost services; this is a group that summarizes costs for the appraiser; they provide manuals and other information to use in making the appraisal

Cost approaches Estimating the costs for construction of buildings can be very time consuming and tedious Depreciation difference between the cost to reproduce or replace property and its contributory value as of the date of the appraisal Physical deterioration; Functional obsolescence Defects in design; material, design, otherwise obsolete by current standards Sometimes this could be cured External obsolescence; effect on value from outside property itself; traffic, odor, hazards, etc

Depreciation examples Corn used to be harvested on the ear and stored in ‘cribs’. Today most of the cribs have been abandoned. This is an example of – Functional depreciation A modern hog confinement needs greater ventilation of the waste pits. This is an example of: – Functional depreciation Asphalt singles on the garage are starting to leak. This is an example of: – Physical depreciation A ethanol plant is located across the road. The resulting dust, traffic, etc. would cause: – External obsolescence What is an economic term for this?

Physical depreciation Curable; this is when the deterioration is economically feasible to cure and they generally are taken care of; deferred maintenance; be sure to include all costs! Physical incurable; this is when the deterioration either can’t be corrected or it would cost more to correct than its contributory value to the property – Short lived; roof, furnace, etc. that would be replaced some time but not at the time of the appraisal – Long lived; basically the ones that will last the life of the improvement; foundation, etc.

Estimating depreciation Economic age-life method: – Depreciation = Effective age/economic life * replacement cost Actual age is when it was built but there could have been extensive remodeling that would change the effective age; the effective age is based on condition and utility of the structure; there are judgments that has to be made Economic life is the time where the improvements contribute to the property value; they can be extended Remaining economic life is time left where the improvements continue to contribute to the property value

Estimating depreciation Econ. life = effective age + remaining econ. life Effective age = Econ. Life - remaining econ. life Remaining econ. life = Econ. life - effective age A major problem with this approach is that it groups the types of depreciation together.

Example Reproduction cost$100,000 Effective age 10 yrs Economic life 50 yrs Remaining econ. life 40 yrs. Ratio for cost 20% – Total Depreciation $20,000 Depreciated value of improv. $80,000 Land value $250,000 Value indicated by cost approach $330,000

Modified Econ. Age/life method The appraiser can recognize the curable items of physical deterioration and functional obsolescence by estimating the cost to ‘cure’ them. This amount is then subtracted from the replacement costs. The appraiser has to recognize the impact this adjustment might have on the effective age and economic life

Example of modified econ. life Reproduction cost $100,000 Minus curable items 3,000 Effective age 9 yrs Economic life 50 yrs Remaining econ. life 41 yrs. Ratio for cost(9/50) 18% RC minus the curable $97,000 – Other depreciation 17,460 – Total Depreciation (+ $3,000) $20,460 Depreciated value of improv. $79,540 Land value $250,000 Value indicated by cost approach (rounded $329,500

Estimating Depreciation Market abstraction – First step is to estimate the depreciation from a sale – Second step is to apply this estimate to the subject building This works for properties either with similar problems as the subject with respect to curable and incurable or for properties without physical curable or incurable short live items The appraiser is trying to estimate the annual percentage depreciation from the sale and apply it to the subject

Annual Percent depreciation example Sales price$400,000 Land value $100,000 Contributory value of improve. $300,000 Reproduction cost new (RCN) $500,000 Accrued Depreciation ($500,000 - $300,000) $200,000 Overall percentage ($200/$500) 40% Effective age 10 Annual percent depreciation 4%/yr.

Application to the subject Reproduction cost $600,000 Effective age 15 years Total depreciation percentage 60% Total depreciation ($600,000 * 60%) $360,000 Contributory value of improvements $240,000 Land value$150,000 Value estimated by cost approach$390,000

Considering curable items The market abstraction approach can also be modified to consider the curable depreciable items Similar process

Sales price $1,700,000 Land value $100,000 Contributory value of improve. $1,600,000 Reproduction cost new (RCN) $2,875,000 Accrued Depreciation (RCN – contrib. value) $1,275,000 Physically curable 200,000 Long lived depreciation 1,075,000 Long lived costs (RCN – curable) $2,675,000 Long lived dep. ($1,075/$2,675) 40% Effective age 20 Annual percent depreciation 2%/yr.

Reconciling the estimates Remember that the whole purpose of this is to come up with an estimated value for the property. We want to correlate the values indicated from the different approaches we used and to come up with a single value. “Reconciliation is the method of bringing together all of the data and analyses into one final estimate of value.”

Reconciling the estimates The reliability of the data is crucial, garbage in, garbage out A wide spread in the estimates from the different approaches indicates a strong possibility there were mathematical and/or technical errors made. In theory, all of the approaches should lead to the same estimate. But, for this you need; – The markets to function perfectly – The appraiser to function perfectly

Reconciling the estimates That’s not likely to happen – The market is the market and sometimes things don’t happen the way you’d expect. I think this is especially true with land and land values – It is important to strive for perfection but don’t let that get in the way of being honest; don’t manipulate data beyond its limits; one paired sale isn’t the same as multiple and so on At the end, don’t forget to ask yourself, if the property is really worth the value stated!