The cost approach

Build the value from its parts

The cost approach applies substitution: a buyer generally would not pay more than the cost of acquiring comparable land and constructing equally useful improvements, assuming no undue delay.

Value indication = land value + current improvement cost minus accumulated depreciation. Estimate land as though vacant and available for its highest and best use, commonly using comparable land sales. Depreciate improvements, not the land.

Choose the cost basis

Replacement cost creates equivalent utility using modern materials, design, and standards. Reproduction cost creates a replica of the existing building, including its design and materials. Use current costs, not historical expenditures. Include appropriate direct costs, such as labor and materials; indirect costs, such as permits and professional fees; and market-supported entrepreneurial incentive.

Deduct loss in value

Appraisal depreciation is loss in value from any cause, distinct from tax depreciation.

• Physical deterioration: wear or damage, such as a worn roof.
• Functional obsolescence: an internal utility problem, such as an inefficient layout.
• External obsolescence: an outside influence, such as nearby industrial noise.

A defect is economically curable when correction adds at least as much value as it costs. External obsolescence is generally incurable by the owner. A simple age-life estimate is effective age divided by total economic life, multiplied by improvement cost. Effective age reflects condition and utility rather than just elapsed years. Avoid double-counting losses when combining depreciation estimates.

Work the formula

Land value is $150,000, new improvement cost is $400,000, and depreciation is $60,000. Depreciated improvements equal $400,000 minus $60,000 = $340,000. Adding $150,000 in land gives a $490,000 value indication.

The approach is particularly useful for new construction and special-purpose properties with few comparable sales. Older improvements can make depreciation harder to estimate. Cost is evidence of value, not assurance that buyers will reimburse every expense.