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16.4 The Cost Approach
16.4 The Cost Approach
The cost approach estimates value by adding the land value to the current cost to build the improvements, then subtracting depreciation. It’s especially useful for newer properties and special-purpose buildings where comparable sales are limited.
The Core Idea (Cost New Minus Depreciation)
The cost approach is based on the idea that a buyer won’t pay more for a property than it would cost to buy the land and build a similar improvement—minus depreciation.
In simple terms:
Estimated Value = Land Value + (Cost New − Depreciation)
Reproduction Cost vs. Replacement Cost
- Reproduction cost: cost to build an exact replica using the same materials and design.
- Replacement cost: cost to build a property with equal utility using modern materials and standards.
Exam-friendly takeaway: Replacement cost is used more often in typical residential appraisal because it reflects modern building methods.
Depreciation (What Gets Subtracted)
Depreciation is any loss in value from the cost new of the improvements. In appraisal, depreciation is commonly grouped into:
- Physical deterioration (wear and tear)
- Functional obsolescence (layout/design/features that are outdated or undesirable)
- External obsolescence (negative influences outside the property, like traffic, nearby nuisances, or market conditions)
Helpful distinction: Physical and functional issues may be curable or incurable. External obsolescence is typically considered incurable by the property owner.
Steps in the Cost Approach
- Estimate land value.
- Estimate reproduction or replacement cost of improvements.
- Estimate accrued depreciation.
- Subtract depreciation from the reproduction/replacement cost.
- Add land value to the depreciated cost of improvements.
Cost Approach Illustration
What to notice: The illustration shows land value + cost new, then subtracts depreciation to reach an indicated value by the cost approach.
Quick Check-Ins (Self-Test)
1) The cost approach is MOST useful when:
- A. The property is brand new or nearly new
- B. There are hundreds of identical recent sales
- C. The property is valued only by rent
- D. The buyer is paying cash
Show Answer
Correct: A. The cost approach is especially helpful for newer properties and special-purpose buildings.
2) Which type of depreciation is caused by factors outside the property?
- A. Physical deterioration
- B. Functional obsolescence
- C. External obsolescence
- D. Replacement cost
Show Answer
Correct: C. External obsolescence comes from outside influences (location/market/environmental factors).