Cost Approach to Value Flashcards

Cost Approach to Value Flashcards NOTESProperty Value by Cost Approach formula requires three

separate steps, which include:1. estimating the

reproduction or replacement cost of the improvements;2.estimating depreciation;3. estimating the value of the land.An appraiser estimates the reproduction cost of a home at $220,000. The home has an economic life of 60 years, and an effective age of 15 years. Under the economic age-life

method, depreciation would be calculated as follows:15 /60

= 0.25 (25%) accrued depreciation rate0.25 x $220,000= $55,000 accrued depreciation$220,000 - $55,000 = $165,000 depreciated value of improvement

ECONOMIC AGE-LIFE METHOD - 4

DEPRECIATIONA loss in the value of an improvement as compared to its cost due to any reason whatsoever. Depreciation is the difference between the market value of the improvement and its cost.LONG-LIVED ITEMA component of the improvement that is expected to last as long as the building itself does NOTESReplacement cost estimates are usually lower than reproduction cost estimates because it usually costs less to build a structure using modem materials and techniques.EXTERNAL or ECONOMIC OBSOLESCENCEA loss in value resulting from causes arising outside of the property itself. The most commoncauses of external obsolescence are negative influences from surrounding properties,and poor local economic conditions.UNIT-IN-PLACE METHODRequires the appraiser to measure the quantities of various building components, such as foundation, floor, walls, roof, doors, windows, etc. The quantityof each item is then multiplied by its appropriate unit cost, and the subtotals for the building components are added together to get the total cost A subject property suffers from functional obsolescence due to a poor floor plan. The market analysis reveals that comparable houses with similar floor plans sell for $110,000, while comparable houses with more functional floor plans sell for $120,000. This indicates that the functional obsolescence due to the poor floor plan causes depreciation of $10,000 ($120,000 - $110,000 = $10,000).

CAPITALIZATION METHOD

SQUARE FOOTAGEMultiply length times width, first measuring the outside dimensions of the building to break it down into rectangles and triangles.

ECONOMIC LIFEThe length of time during which the improvement will contribute to the value of the property SUPERADEQUACIESForms of over improvement; design features whose costs are greater than their contribution to value.EFFECTIVE AGEThe apparent or functional age of the improvement, based on its current conditions and the current conditions in the market. Effective age may be the same as actual age, or it may be greater or less than actual age. Effective age is related to remaining economic life.The methods of estimating depreciationA. Economic Age-Life MethodB. Sales Comparison MethodC. Capitalization MethodD. Cost to Cure MethodE.Observed Condition Method UNIT COST BY MARKET ANALYSIS (Unit Cost) The appraiser gathers data on the sales of comparable new homes. The comparables must be similar to the subject property in both size and quality of construction, and the appraiser must be able to determine the site values for the comparables. The appraiser subtracts the site value from the sales price and then divides the result by the square footage of the comparable. The result is the unit cost.UNIT COST BY MARKET ANALYSIS (Per Square Foot) A new 1,500 square foot rambler sold recently for $120,000. Market data support the appraiser's estimate of the site value for this property of $30,000, so the building value is $90,000 ($120,000 sales price, $30,000 site value). Assuming the home does not suffer from any depreciation, its value should be equivalent to its cost. So the appraiser takes $90,000 (the building value or cost) and divides that by 1,500 the size in square feet. The result, $60 per square foot, becomes the unit cost.FUNCTIONAL OBSOLESCENCEIn addition to physical wear and tear, an improvement can suffer from depreciation that is caused by DESIGN defects.Functional obsolescence is "built-in" obsolescence NOTESThe cost approach to value is the best approach for service type buildings where there are few comparables and the income is not appropriate. As an example, an appraiser would use the cost approach to appraise an athletic stadium. The cost approach is also appropriate for newer structures. The older the structure the less reliable is the approach, since the determination of accrued DEPRECIATION is somewhat subjective. As an example, the cost approach could be used for a new home but would likely provide an unrealistic value in appraising a 40-year-old single-family residence.REPLACEMENT COSTThe cost to build a new substitute improvement at current prices with modem materials, and according to current

standards, design and layout, as of the effective date of the appraisal.

COMPARATIVE UNIT METHODCost is estimated on the basis of the square footage of building area, or the cubic footage of building volume.Residential cost estimates using this technique always use square footage, so it is often referred to as the square foot method.Estimating depreciation is similar to the sales comparison method. As in the sales comparison method, the appraiser must be able to identify comparable rental properties that contain the particular defect and those that do not. The difference in income between the two sets of properties is then capitalized to arrive at a figure for the amount of depreciation caused by the defect

CAPITALIZATION METHOD - 2

Cost Estimating Manuals or ServicesInstead of estimating the unit cost, an appraiser may use local builders and developers, as well as published cost manuals and professional costing services, to find the unit cost. Some widely used cost manuals are published by Boeckh Publications, F. W. Dodge Corporation owned by Marshall and Swift Publication Company, Marshall and Swift Publication Company, and R. S. Means Company.Cost manuals are published periodically usually quarterly and list the average unit costs for different sizes and styles of construction.NOTESThe term depreciation is also widely used to refer to the amount of an asset's capitalvalue that has been "written off" for accounting or tax purposes. This kind of depreciation is sometimes called BOOK depreciation and has no significance from an appraisal standpoint.NOTESIf the cost to correct the deterioration is less than the added value that would result from the correction, then it is CURABLE. Otherwise, it is INCURABLE depreciation NOTESSquare footage is calculated by measuring and multiplying the outside dimensions, length x width of the building.PHYSICAL DETERIORATIONDepreciation that is caused by wear and tear of, or damage to, the physical components of the improvement. Broken windows, leaky roofs, peeling paint, termite damage or worn carpeting are all examples of physical deterioration.NOTESAn exceptionally well-maintained building might have a chronological age of 20 years but an appraiser might use an effective age of 14 years to determine the depreciation.UpdatedA residential property would include refurbishing and/or replacing components tomeet existing market exppectations. This does not include significant alterations to the existingstructure.REMAINING ECONOMIC LIFEThe amount of time from the effective date of the appraisal until the end of the improvement's economic life.