Week 10 - The Cost Approach

Question 1

Define cost approach

Answer 1

A property is valued based on a comparison with the cost to build a new or substitute property
The cost estimate is adjusted for the depreciation evident in the existing property

A set of procedures through which a value indication is derived for the freehold interest in a property by estimating the current cost to construct a reproduction of the existing structure, including an entrepreneurial incentive, deducing depreciation from the total cost and adding the estimated land value

“Costs” includes entrepreneurial incentive (agents of production)

Question 2

What is the pricinple of the cost approach

Answer 2

-segregating the land component and the improvement/ building component

Land + building component - obsolescence (depreciation) = estimated value of property

Note land is not depreciable unlike the physical building

Question 3

What is market extracted depreciation

Answer 3

One way to estimate depreciation:

Costs to bring an existing structure up to the physical condition and functional Utility they desire

Question 4

Difference between cost, price and value

Answer 4

Price = refers to the amount a particular purchaser agrees to pay and a particular seller agrees to accept (recorded fact)

Cost= used by valuer in relation to production, not exchange. Cost may be either an accomplished fact or a current estimate (can be estimated)

Value - must be specific since there are many kinds of value e.g. Market value

Question 5

How does highest and best use relate to cost approach

Answer 5

Buyers are likely to judge the value not only by the prices and rents but also the cost to create a new building with optimal physical condition and functional utility

• not only looking at income side by also cost side in order to bring dwelling in alignment with markets contemporary desires

Question 6

Agents of production

Answer 6

Land
Labour
Capital
Entrepreneurial incentive

Question 7

Three types of depreciation

Answer 7

Physical depreciation - natural wear and tear
Functional obsolescence - outdated features e.g design
External obsolescence - feature out of the property e.g. Economic, neg externalities

Question 8

Explain types of ‘construction costs’ in the cost approach

Answer 8

DIRECT:
Labour materials
Equipment

INDIRECT:
Administration 
Professional fees 
Financing costs
Tax
Insurance
Marketing
Lawyers 
Entrepreneur incentive (Llk

Question 9

Define direct costs

Answer 9

Expenditure for the labour and materials used in the construction of improvements also called “hard costs”

Question 10

Define indirect costs:

Answer 10

Expenditure of allowance for items other than labour and materials that are necessary for construction but are not typically part of the construction contract also called “soft costs”

Question 11

Define depreciation

Answer 11

Difference between contributory value of an improvement and its cost at time of valuation

Dep= cost of improvement - contributory value of improvement

Depreciation cost= current cost - total depreciation

Market value = depreciated cost + site value

Question 12

What are the 3 methods of estimating costs in the cost approach

Answer 12

1. ) comparative unit - dollars per unit of area or volume based on known costs of similar structures that are adjusted for time and physical differences
2. ) unit-in-place - individual costs for building components
3. ) quantity survey method - quantity and quality of all materials used and all categories of labour required are estimated (comprehensive approach)

Question 13

What are the 3 methods of depreciation in the cost approach

Answer 13

Market extraction

Economic age life

Breakdown

Question 14

Applicability of cost approach:

Answer 14

The cost approach is important when a lack of market activity limits use of the direct comparison approach and when the property is not suitable for income cap

More useful when properties are new (as limited depreciation needed to be calculated)

Question 15

Limitations of cost approach:

Answer 15

When properties are older they are less likely to have accurate estimation of depreciation

Hard to estimate accurate level of developers profit

Immediate availability of the completed project lack reality and practicality

The cost approach result in a value estimation of the freehold interest - leased fee or partial

When no land sales available

When construction costs difficult to measure

Question 16

Explain cost approach steps

Answer 16

Estimate the value of the site as vacant land
Determine whether reproduction cost or replacement cost will be used
Estimate direct and indirect costs of improvements
Estimate an appropriate developer’s profit or incentive from analysis of market
Add costs
Estimate the amount of depreciation in the structure
Deduced depreciation from cost of improvement
Estimate additional improvements not considered
Add in step one estimate value of site
Make adjustments for personal property and intangible assets

Question 17

Define replacement costs

Answer 17

estimated costs to construct a substitute for the building being valued using modern materials and current standards, design and layout.

Question 18

Define reproduction costs

Answer 18

The estimated cost to construct an exact duplicate or replaca of the building being valued, using same materials, standards, design, layout and quality
and embodying all the deficiencies, super adequacies and obsolescence of the subject building

Question 19

depreciation in an improvement can result from 3 major causes

Answer 19

physical deterioration - wear + tear

functional detonation - structure, design + utility

External obsolescence - temporary or permeant impairment of utility due to negative influences OUTSIDE the property

Question 20

Define comparative unit method

Answer 20

method used to deprive cost estimate in dollar terms of permit area or volume based on known costs of similar structures that are adjusted for time + physical differences
(usually applied to total building area)

Question 21

Define unit in place method

Answer 21

Cost estimating method in which total building costs are estimated by adding together unit costs for various building components as installed
also called segregated cost-method

Question 22

Define quantity survey method

Answer 22

Cost estimating method in which the quantity + quality of materials used and all categories of labour required are estimated and unit figure costs are applied

Question 23

Define curable / un curable

Answer 23

items of physical or functional obsolescence are economically feasible to cure if the cost to cure equal or less than the estimated increase in value of the property

If cost to cure is more than anticipated increase in property value than item is incurable

Question 24

Define economic life

Answer 24

period over which improvements to real property contribute to property value

Question 25

Define useful life

Answer 25

period of time over which a structure or component may reasonably be expected to perform the function for which it was designed