Property Valuation Methodology: The Cost Approach
What Is It?
The Cost Approach estimates the replacement value of a property by analysing the cost of its components, i.e. land and building. It lies somewhere between the inferred and the intrinsic methods, and is not a fully autonomous valuation method.
Value is calculated by adding the free market value of the land as if vacant to the reconstruction cost of the building, minus depreciation suffered over the years in comparison to a new building.
Procedure
- Estimate the value of the land as if vacant, by comparing it to similar properties.
- Estimate the replacement cost of the building at present. Factors to be considered include site preparation, utilities, types of building improvements, tenant improvements, and soft costs.
- Assess the depreciation that has occurred to the building and deduct the figure from the replacement cost of the building.
- Add the estimated worth of the land, and the resulting figure will be an indication of the value of the property.
Example:
Market value of land: £100,000
Replacement cost of the building: £500,000
Depreciation: £75,000
Value of property: £525,000 = £100,000 + £500,000 - £75,000
Advantages and Disadvantages
This method sets the value at the actual cost or price of the property, however it relies upon other valuation methods to derive the value of the land. Furthermore, it neglects the difference between cost and value, namely that one property might be cheaper than another but generate a much higher net income.
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