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.

• The mixing the cost approach and the sales approach is not correct; the cost approach uses a different methodology.

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 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 approach

• Outline– 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

• 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 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

• Subject property has 160 acres of pasture with fences and stock pond

• Three other sales are located for $800 an acre all with similar fencing and water

• The indicated value of $800 would include the fence and water

• If an appraiser valued the land at $800 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

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 then used to estimate the values

for the various classes of land on the subject property

• Values are applied similar to the subject WITHOUT making the plus or minus adjustments that we used in the Sales comparison approach (except be sure you still make the time adjustments)

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– 22 acres Total non-tillable$2,534 $ 55,750– 147 acres $6,923

$1,017,750

Sales analysis

• Assume we have identified 4 unimproved sales with similar location, -12% annual decline

Sale 1 Sale 2 Sale 3 Sale 4Date Current 1 yr Current 2yrsPrice $160,000 173,250 176,250 156,000Land 100 crop 85 crop 100 crop 50 crop

0 past. 20 past 20 past 50 past.Time adjust.

0 -20,790 0 -$35,193Adjusted price $160,000 152,460 176,250 120,807Per acre $1,600 $1,452 $1,469 $1,208

Analysis

Analysis

What is the value of pasture in Sales 4?

• Adjusted price $120,806• 50 acres crop• 50 acres pasture

Analysis

Analysis• Subject– 75 acres crop $1,600/ac $120,000– 25 acres Pasture $815 20,375

$140,375

Cost approaches

• Depreciation difference between the cost to reproduce or replace property and its contributory value as of the date of the appraisal

• 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.