1. Introducing The Cost Approach
Chapter 11
Introducing The Cost Approach
Basic Real Estate Appraisal: Principles & Procedures – 9th Edition
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2. STUDENT LEARNING OUTCOMES
Page344
List the Five Basic Steps in the Cost Approach
Define the Terms Reproduction Cost and Replacement Cost, and explain their use in Appraisals
Name Four Methods of Estimating Costs and explain when each is used
List the Direct and Indirect Costs that make up a Building’s Cost
Name Important Site, Location and Design Features that Influence Costs of a Building
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3. 11.1 USE OF COST ESTIMATES IN VALUATIONS
Page 345
For Use in Appraisals, Cost means…
Cost Levels on Date of Value
Not “Book” or “Historic” Costs
Typical Costs (rather than actual)
Consumer Level Cost (“Turn-Key”)
Cost As-If New
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4. PURPOSE & OUTLINE OF COST APPROACH
Page 345
Estimate the Value of New (or nearly new) and Economically Sound Developments
Appraisal of Institutional or Special-Use Properties; May be the Only Approach
To Use as a Check against the Other Approaches
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5. STEPS IN THE COST APPROACH
Page 346
Estimate the Value of the Land as if vacant and available for use; typically by Market Approach
Estimate the Total Cost to Reproduce or Replace the existing improvements as of the date of value.
Decide on appropriate amounts for Accrued Depreciation (loss in market value from cost new)
Deduct the Accrued Depreciation from the cost new of the improvements.
Add the Depreciated Cost of the Improvements to the Estimated Land Value, in order to arrive at the property value by the Cost Approach.
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6. REPRODUCTION OR REPLACEMENT?
Page 347
Reproduction Cost
The Cost of Creating a Duplicate or Nearly Identical Structure; Every Physical Component Must be Included
Replacement Cost
The Cost a Structure of Similar Utility; may exclude Features or Components that do not add to attractiveness or marketability
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7. REPLACEMENT VS. REPRODUCTION
Page 349
Subject Property
Reproduce a Replica
Replace the Utility
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8. REPLACEMENT VS. REPRODUCTION
Page 349
Use of Replacement Costs
Avoids Making Difficult and Time-Consuming Estimates of Out-Dated Materials and Features
Provides a Direct Rating of Market Preferences
Most Likely Used for Loan Purposes
Use of Reproduction Costs
Helps Demonstrate Functional Obsolescence
Choice Will Likely Depend on Intended Use
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9. 11.2 COST-ESTIMATING METHODS
Page 351
There are Four Methods
Comparative Square-Foot Method
Most Widely Used & Most Practical
Uses Typical Average Costs from a Cost Manual
Unit-In-Place Method
Cost for each Building Component / Section
Often used to Modify / Adjust Comparative Square-Foot Method Estimates
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10. COST-ESTIMATING METHODS (Con’t.)
Page 353
Index Method
Used for Unique or Unusual Structures for which Original or Historical Costs are Known
Adjusts Historical Costs to Cost Level on Value Date by using Published Cost Indexing Factors
Quantity Survey Method
Most Detailed and Accurate / Precise
Used Mainly by Contractors versus Appraisers
See Table 11.1 on Page 355
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11. 11.3 UNDERSTANDING DIRECT AND INDIRECT COSTS
Page 356
For Valuation Purposes – Cost Estimates Should Include All Expenditures to Deliver it for Use to the Consumer Level
Builder’s Cost Estimates and those from Cost Services Fail to Account for All Direct and Indirect Costs of Construction
If All Costs are not accounted for – the Cost Approach Value Indicator may not Relate to the Defined Value
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12. DIRECT COSTS Labor Costs Materials and Equipment
Page 356
Labor Costs
Materials and Equipment
Design and Engineering
Subcontractor’s Fees
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13. INDIRECT COSTS
Page 358
Legal Fees, Appraisals, Building Permits and Local Development Impact Fees
Interest on Construction Financing (+ Fees)
Liability & Casualty Insurance
Property Taxes During Construction
Administration & Management (Overhead)
Interest on Invested Funds (i.e. Return on Land $)
Builder’s & Developer’s (Entrepreneurial) Profit
Marketing & Selling Costs
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14. 11.4 FACTORS AFFECTING COST
Page 361
Site and Location Factors
Size & Shape of Site
Topography, Soils Conditions, Geology
Climate
Regional Costs of Labor and Materials
Building Code Requirements (Jurisdictional)
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15. FACTORS AFFECTING COST (Con’t.)
Page 362
Design & Construction Cost Variables
Design or Use Type (Occupancy)
Construction Classification
Quality of Construction
Building Size and Shape (see next slide)
Wall or Story Height
Yard or Site Improvements
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16. EFFECT OF SIZE ON SQ-FT COSTS
Page 365
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17. EFFECT OF SHAPE ON SQ-FT COSTS
Page 366
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18. EFFECT OF SHAPE ON SQ-FT COSTS
Page 366
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19. USING BUILDING COST SERVICES
Page 367
Published Manuals, CD’s, and Online
Marshall & Swift (CoreLogic), Means, and Bluebook are common services
Many provide both Comparative Square-Foot & Unit-In-Place Costs
May not include all Indirect Costs; and will need to be added
Adjustments for Time & Location Required
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20. CHAPTER SUMMARY
Page 369
Cost estimating plays a role in each of the three approaches to value. In appraisals, the concept of cost is related to its economic impact. This means that cost estimates are made at price levels as of the date of value. Also, they must reflect the total amount of typical costs that are passed on to consumers (“turn-key”).
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21. CHAPTER SUMMARY (Con’t.)
Page 370
The cost approach is used primarily to estimate the value of nearly new, new, or special-use properties. It can also be a check against the other value approaches. There are Four Methods commonly used: Comparative Square-Foot (easiest and most common); Unit-In-Place; Index; and Quantity Survey (most accurate).
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22. CHAPTER SUMMARY (Con’t.)
Page 370
Cost Estimates must account for All Direct and Indirect Costs of Construction. Cost levels can be affected by Site, Location and various Construction / Building Features. Published Cost Services are a good source for typical cost estimates, but require some adjustment for Indirect Costs that may not be included, along with time and location.
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23. IMPORTANT TERMS & CONCEPTS
Page 371
Base Cost
Direct Costs
Builder’s Profit
Historic Costs
Building Shell
Index Method
Building Size and Shape
Indirect Costs
Comparative Square-Foot Method
Lump-Sum Costs
Construction Classification
Quantity Survey Method
Cost Approach
Replacement Cost
Cost Manuals
Reproduction Cost
Design Type or Use Type
Story Height
Developer or Entrepreneurial Profit
Unit-In-Place Method
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