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Cost approach. Basic idea is that an informed buyer won’t pay more than the cost of constructing an equal, substitute property minus the depreciation and assuming no delay. Market data is used to value the components of the subject property including the land.

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cost approach
Cost approach
  • Basic idea is that an informed buyer won’t pay more than the cost of constructing an equal, substitute property minus the depreciation and assuming no delay.
  • Market data is used to value the components of the subject property including the land.
  • Even though both the cost and sales comparison approaches use market data DO NOT mix the two; the cost approach uses a different methodology.
cost approach3
Cost approach
  • Most applicable when:
    • Improvements are new and are highest and best use
    • Subject property has characteristics typical in the area
    • Subject property is a special use property
    • Enough data to value the property components but limited data to value the whole property
cost approach4
Cost approach
  • Least applicable when:
    • No vacant land sales available
    • Construction costs are hard to measure
    • Depreciation is hard to measure
    • Improvements are very old
cost approach5
Cost approach
  • Steps:
    • Develop a land value opinion; vacant land in highest and best use valued as highest and best use regardless of present use. Use similar highest and best use
    • Estimate reproduction or replacement costs for improvements.
    • Estimate amount of depreciation
    • Subtract the depreciation from the cost estimate
    • Total the land and building components
format
Format
  • New cost of improvements $300,000
  • Depreciation -175,000
  • Depreciated value of improvements $125,000
  • Value of the land $600,000
  • Value from Cost Approach $725,000
land in the cost approach
Land in the cost approach
  • Land value is the value for vacant land
  • Unimproved is land without building or structures
    • Urban usually means land without a house/structure even if there are roads, sewer, etc.
    • Rural unimproved doesn’t mean there aren’t fences, tile, ponds, etc. Just that there are no buildings or structures.
    • Why?
example
Example
  • Subject property has 160 acres of pasture with fences and stock pond
  • Three other sales are located for $2800 an acre all with similar fencing and water
  • The indicated value of $2800 would include the fence and water
  • If an appraiser valued the land at $2800 and then added the value of the fence and water they’d be overstating
  • If the request was for an appraisal that valued them separately then the other 3 sales would have to be allocated between the land and site improvements
slide9
Land
  • The Cost approach inventories the land for the subject property into various classes
    • Cropland, tillable pasture, permanent pasture, woodland, farmstead roads, ditches, etc.
  • Vacant sales are used to estimate the values for the various classes of land on the subject property
  • Values are applied to the subject WITHOUT making the plus or minus adjustments used in the Sales comparison approach (except be sure you still make the time adjustments)
example10
Example
  • Tillable ground:
    • 90 + CSR Cropland A
    • 85 – 90 CSR Cropland B
        • 50 acres of Cropland A $8,000/ac $400,000
        • 75 acres of Cropland B 7,500 562,000

Total tillable $962,000

        • 15 acres of pasture $1,050 $ 15,750
        • 5 acres of farmstead $8,000 $ 40,000
        • 2 acres of roads/ditches 0 0
        • Total non-tillable $ 55,750
        • 22 acres $2,534
        • TOTAL $1,017,750
        • 147 acres $6,923
cost approach cont
Cost approach (cont)
  • Value of the land determined first
  • Cost for the building;
    • Reproduction; cost to construct an exact replica of the existing building
    • Replacement; cost to construct a building with the utility equivalent to the one being appraised; using modern material, current standards, design, layout, etc.
  • Using either method use the date of the appraisal and with current prices
data sources
Data sources
  • Local builders
  • Market abstraction; based on sale of a new building after the land is subtracted; works best with houses, not so good with rural property
  • Cost services; this is a group that summarizes costs for the appraiser; they provide manuals and other information to use in making the appraisal
cost approaches
Cost approaches
  • Depreciation is the difference between the cost to reproduce or replace property and its contributory value as of the date of the appraisal
  • Three types of depreciation to consider:
    • Physical deterioration;
    • Functional obsolescence Defects in design; material, design, otherwise obsolete by current standards Sometimes this could be cured
    • External obsolescence; effect on value from outside property itself; traffic, odor, hazards, etc
depreciation examples
Depreciation examples
  • Corn used to be harvested on the ear and stored in ‘cribs’. Today most of the cribs have been abandoned. This is an example of
    • Functional depreciation
  • A modern hog confinement needs greater ventilation of the waste pits. This is an example of:
    • Functional depreciation
  • Asphalt singles on the garage are starting to leak. This is an example of:
    • Physical depreciation
  • A ethanol plant is located across the road. The resulting dust, traffic, etc. would cause:
    • External obsolescence
      • What is an economic term for this?
physical depreciation
Physical depreciation
  • Two kinds of physical depreciation to remember:
  • Curable; this is when the deterioration is economically feasible to cure and they generally are taken care of; deferred maintenance; be sure to include all costs!
  • Physical incurable; this is when the deterioration either can’t be corrected or it would cost more to correct than its contributory value to the property
    • Short lived; roof, furnace, etc. that would be replaced some time but not at the time of the appraisal
    • Long lived; basically the ones that will last the life of the improvement; foundation, etc.
estimating depreciation
Estimating depreciation
  • Economic age-life method:
    • Depreciation = Effective age/economic life * replacement cost
  • Actual age is when it was built but there could have been extensive remodeling that would change the effective age; the effective age is based on condition and utility of the structure; there are judgments that has to be made
  • Economic life is the time where the improvements contribute to the property value; they can be extended
  • Remaining economic life is time left where the improvements continue to contribute to the property value
estimating depreciation17
Estimating depreciation
  • Econ. life = effective age + remaining econ. life
  • Effective age = Econ. Life - remaining econ. life
  • Remaining econ. life = Econ. life - effective age
  • A major problem with this approach is that it groups the types of depreciation together.
example18
Example
  • Reproduction cost $100,000
  • Effective age 10 yrs
  • Economic life 50 yrs
  • Remaining econ. life 40 yrs.
  • Ratio for cost 20%
    • Total Depreciation $20,000
  • Depreciated value of improv. $80,000
  • Land value $250,000
  • Value indicated by cost approach

$330,000

modified econ age life method
Modified Econ. Age/life method
  • The appraiser can recognize the curable items of physical deterioration and functional obsolescence by estimating the cost to ‘cure’ them.
  • This amount is then subtracted from the replacement costs.
  • The appraiser has to recognize the impact this adjustment might have on the effective age and economic life
example of modified econ life
Example of modified econ. life
  • Reproduction cost $100,000
  • Minus curable items $3,000
  • Effective age 9 yrs
  • Economic life 50 yrs
  • Remaining econ. life 41 yrs.
  • Ratio for cost (9/50) 18%
  • RC minus the curable $97,000
    • Other depreciation 17,460
    • Total Depreciation (+ $3,000) $20,460
  • Depreciated value of improv. $79,540
  • Land value $250,000
  • Value indicated by cost approach (rounded

$329,500

estimating depreciation21
Estimating Depreciation
  • Market abstraction
    • First step is to estimate the depreciation from a sale
    • Second step is to apply this estimate to the subject building
  • This works for properties either with similar problems as the subject with respect to curable and incurable or for properties without physical curable or incurable short live items
  • The appraiser is trying to estimate the annual percentage depreciation from the sale and apply it to the subject
annual percent depreciation example
Annual Percent depreciation example
  • Sales price $400,000
  • Land value $100,000
  • Contributory value of improve. $300,000
  • Reproduction cost new (RCN) $500,000
  • Accrued Depreciation ($500,000 - $300,000)

$200,000

  • Overall percentage ($200/$500) 40%
  • Effective age 10
  • Annual percent depreciation 4%/yr.
application to the subject
Application to the subject
  • Reproduction cost $600,000
  • Effective age 15 years
  • Total depreciation percentage 60%
  • Total depreciation ($600,000 * 60%)

$360,000

  • Contributory value of improvements $240,000
  • Land value $150,000
  • Value estimated by cost approach $390,000
considering curable items
Considering curable items
  • The market abstraction approach can also be modified to consider the curable depreciable items
  • Similar process
slide25
Sales price $1,700,000
  • Land value $100,000
  • Contributory value of improve. $1,600,000
  • Reproduction cost new (RCN) $2,875,000
  • Accrued Depreciation (RCN – contrib. value)

$1,275,000

  • Physically curable 200,000
  • Long lived depreciation 1,075,000
  • Long lived costs (RCN – curable) $2,675,000
  • Long lived dep. ($1,075/$2,675)40%
  • Effective age 20
  • Annual percent depreciation 2%/yr.
reconciling the estimates
Reconciling the estimates
  • Remember that the whole purpose of this is to come up with an estimated value for the property.
  • We want to correlate the values indicated from the different approaches we used and to come up with a single value.
  • “Reconciliation is the method of bringing together all of the data and analyses into one final estimate of value.”
reconciling the estimates28
Reconciling the estimates
  • The reliability of the data is crucial, garbage in, garbage out
  • A wide spread in the estimates from the different approaches indicates a strong possibility there were mathematical and/or technical errors made.
  • In theory, all of the approaches should lead to the same estimate. But, for this you need;
    • The markets to function perfectly
    • The appraiser to function perfectly
reconciling the estimates29
Reconciling the estimates
  • That’s not likely to happen
    • The market is the market and sometimes things don’t happen the way you’d expect. I think this is especially true with land and land values
    • It is important to strive for perfection but don’t let that get in the way of being honest; don’t manipulate data beyond its limits; one paired sale isn’t the same as multiple and so on
  • At the end, don’t forget to ask yourself, if the property is really worth the value stated!
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