1. The Cost Approach

2. Premise Value is related to the cost to create
Value is the sum of the cost to create all parts of the property
Cost is the money required to assemble and own:
given materials
on a given site
as of a specified date

3. 3 Major Parts of the Cost Approach
Site Value - estimated by appraiser
Total Cost of all improvements
including all direct and indirect costs,
including developer incentive, or profit
Depreciation and Obsolescence
Physical Deterioration
Functional Obsolescence
External Obsolescence

4. Key Points
Always analyzes improvements as of the date of valuation, not original construction date
All parts of the cost approach come from the market if market value is to be estimated

5. Cost of Improvements includes
Direct Costs
labor and materials used in building by the contractor
power, utilities, equipment needed for construction
Contractor’s profit and overhead

6. Cost also includes . . . Indirect Costs include the developer’s:
Architectural and engineering fees, surveys
Consulting, Accounting, Legal, Appraisal
Construction period holding costs, interest, taxes, insurance
marketing, sales, and leasing costs
developer’s administrative expenses

7. And Cost Includes Developer Profit or Incentive
also called entrepreneurial profit
represents the amount the entrepreneur or developer would require and expect to receive for providing:
coordination and management
expertise, and
assumption of risk

8. Developer Profit / Incentive
May be included as
Lump-sum money amount
percent of total site and improvements cost
percent of total improvements cost
percent of equity investment required
which to use depends on how profit incentive was derived from the market.

9. The parties or “profit centers” involved in “cost”
Contractors
Subcontractors
their profit is included in their bids to the developer
their profit is included in the cost factors
Developer
is in the role of entrepreneur, coordinator, manager
brings all the parts together
provides management expertise, and
has the risk - profit is sometimes negative! The market decides.

10. Methods of Cost Estimating
Comparative Unit
I.e. - Square Foot or Cubic Foot
Unit-In-Place
Quantity Survey

11. Comparative Unit
A cost estimate in terms of amount per unit of improvement area by using adjusted known costs of similar structures
indirect costs may be included or computed separately depending on whether included in source data
developer profit normally added separately

12. Unit-in-place Also called “segregated cost’ method
uses cost estimates for various building components as installed
for example: foundation, exterior walls, roof, plumbing system, electrical system, etc.
indirect costs may be included or computed separately depending on whether included in source data
developer profit added separately

13. Quantity Survey
Most detailed, comprehensive, and potentially ‘accurate’ method
includes quantity and quality of all materials and labor, contingencies, and contractor’s profit
includes all direct and indirect costs
developer profit added separately
expensive and time consuming to do

14. Types of Cost Factors
Reproduction Cost is the cost to produce an exact duplicate or replica
Replacement Cost is the cost to produce improvements of equal utility
Know which one you need to use.
Know which one the cost service provides
Note: Replacement costs automatically cures some types of functional obsolescence

15. Layout of Cost Approach
Improvements Cost (include direct & indirect costs and entrepreneurial incentive) is “Cost as though New”
Less Depreciation
Depreciated Cost or Contribution of Improvements
Site Value estimate
Indicated Value by Cost Approach

16. Depreciation
Depreciation is loss in value due to any cause from cost as though new
Three Types
1. Physical Deterioration
2. Functional Obsolescence
3. External Obsolescence
Land or Site does not depreciate
Not the same as accountant’s ‘depreciation” or ‘book depreciation.’

17. Physical Deterioration
Physical ‘wear and tear,’ aging, wearing out.
Curable (repairs, deferred maintenance)
Incurable (basic structure)
Short-Lived and Long Lived Components
Note; The test of curability is economic rather than physical
Physically about anything can be ‘cured’; but it is curable only if it makes economic sense to do so: i.e. if the problem is fixed, is more added to value than the cost to repair?

18. Functional Obsolescence
Loss in value because of inappropriate building style, design, materials, utility - by market standards
Curable: sometimes the problem can be cured or fixed. Curable if cost to cure is less than the value added.
Incurable: When it does not make economic sense to make changes to remove the functional obsolescence.
Curability is an economic consideration, not physical
Obsolescence is by market standards

19. External Obsolescence
Loss in value to the total property, site and improvements, because of adverse influences outside the property boundaries.
May be physical or economic
Always incurable; beyond the owners control
Must be allocated between improvements and site
automatically considered in site value estimate; allocation must be to improvements

20. Reminders about Depreciation
Loss in value from any cause; three types of causes
Depreciation is the difference between cost as though new as of the date of appraisal, and market value

21. Reminders about Depreciation, con’t...
Economic life and age, rather than physical life and calendar age, is the important standard. (“more buildings are torn down than fall down”)
All depreciation is by market standards and amounts must come from the market.

22. Cost Approach is least reliable when
Site value has poor support
Depreciation or obsolescence are involved and require significant judgements about effective life, etc.
Obsolescence cannot be supported from market data
Cost factors are difficult to support; for example with unusual construction, some rural areas.

23. Cost Approach works best when...
Improvements are ‘normal’ and cost estimates can be well supported
Improvements are new, or young, so do not have much depreciation
There is little or no obsolescence
Site value can be supported by recent sales of similar sites

24. Cost Approach should be given strong consideration & influence when...
Amounts involved for cost factors, depreciation, and site value are, or can be, well supported
Buyers think in terms of cost of alternatives in using the Principle of Substitution
i.e. it simulates the thinking of buyers in the market place

25. Apply the Cost Approach with care and market support...
Are there any Questions?