Chapter 4 Cost Approach, Concepts and Definitions Flashcards

Chapter 4 Cost Approach, Concepts and Definitions Flashcards The land value is well supported.Another step in the cost approach is estimating the value of the land or site. If it's a standard lot and there are adequate sales in the marketplace, it becomes a relatively easy and straightforward task to arrive at that value.If the land is unusual in any aspect such as size, shape, topography, utilities, then the difficulty is compounded. If it turns out that the land value is not well-supported, then an unrealistic value might be developed which can throw off the results of the cost approach.Have you ever tried to find land comparable sales for a 100-acre site in a suburban area where virtually all the property sales are two acres or less in size? It doesn't mean that we can't do a cost approach, but the lack of support for the land value might mean the conclusion is suspect.Fee simple estate is defined as:Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.So the basic application of the cost approach formula will indicate the value of a fee simple interest. Of course, even a fee simple interest is still subject to the normal public limitations on ownership. You may own a property free and clear of all encumbrances, no mortgage and with a warranty deed - however, if you fail to pay your taxes, the property will revert to the taxing municipality.A similar definition from the IVS says a fee simple estate

is:Absolute ownership subject only to limitations imposed

by the State; also called a freehold.The building improvements are new or relatively new.The cost approach has good applicability when the improvements we are appraising are new or relatively new.The first step in the cost approach is to estimate the cost new of the building improvements. If it was recently built it most likely was constructed of modern materials, utilizing modern construction techniques.If it was recently built you may be able to ascertain the contract cost. Maybe you can interview the builder or perhaps the plans and costs are on file with the local building department. You might be able to interview the lender or contact the person who appraised that property.As a building gets older and older it will be more difficult to arrive at an estimate of what it would cost to construct that building brand new today. Maybe some of the materials used in that construction are no longer

available. Perhaps there are not skilled artisans available who could do a particular type of craftsmanlike finish. There are not a lot of people out there now who work with slate roofs or who mill gingerbread trim for eaves.So, the difficulties inherent in estimating costs new of older structures include both material costs and labor costs.Besides some of these older structures are lacking in utility to the extent that no one would pay what it would cost to reproduce them today.Approaches to ValueThe cost approach has been around for quite a while. It is the oldest of the three traditional approaches that appraisers use. If you were an appraiser back in 1940, all you would have used was a cost approach.As time went on the sales comparison approach was introduced along with the income approach and its many variations. The fortunes of each approach changed over time as well.Many participants in the residential mortgage market today feel that the sales comparison approach is the only way to go.The 2005 revisions of the Fannie Mae/Freddie Mac residential appraisal reporting forms stress that the cost approach and the income approach are not required by them.Some appraisers denigrate the cost approach and

state that it is rarely useful, while others appreciate its capabilities. There has been an ongoing debate about the applicability of the cost approach in varying situations.There is fairly strong agreement in the thought that the cost approach has diminishing applicability as a property ages. However, there is no common consensus as to where to draw the line. In other words, how old is too old to have the cost approach work adequately? There is no standard answer for this question.Estimating the use value of special purpose properties.Special-purpose properties are sometimes called no-market properties. They represent things that are not normally bought and sold in the marketplace.They include properties such as churches and schools, for example.That's not to say that churches and schools are not occasionally sold, however you would likely be hard-pressed to find a bunch of good church or school comparable sales in your MLS system.Let's say you are appraising a church building. If you can't find a sufficient number of sales of churches and they are not normally bought for income-producing purposes, then that rules out the sales comparison approach and the income

capitalization approach as possibilities. You only have one approach left.So even though we say the cost approach has applicability in estimating the value of special-purpose properties, sometimes it's really that it's the only way to go, by default. I have appraised several churches. I could not find comparable sales, but I could do a cost approach.I looked in my cost manual and found cost figures for that type of construction along with what it would cost to add such specialty items as stained-glass windows, steeples, and pews. Then I subtracted depreciation and added in land value. I was able to estimate value by the cost approach and that was my final value conclusion.I have successfully used the cost approach as my one and only indicator of value on such special purpose properties as schools, an oil storage tank facility, a brick manufacturing plant, and quite a few special-purpose industrial properties such as an asphalt rendering plant and a bottling plant.When nothing else works, the cost approach usually will!Reproduction cost is defined as:The estimated cost to construct, at current prices as of the effective date of the appraisal, an exact duplicate or replica of the building being appraised, using the same materials, construction standards, design, layout, and quality of workmanship and embodying all the deficiencies, superadequacies, and obsolescence of the subject building.The companion definition from the IVS for

Reproduction Cost (new) is:The cost to create a virtual

replica of the existing structure, employing the same design and similar building materials. The current cost of an identical new item.