Cost Approach to Real Estate Valuations

Picking up where we left off in our last conversation there are three common approaches to valuation and in this series we will explore each type.  The first of which is the Cost Approach, commonly used for new or proposed construction valuation and to provide a highly effective way to verify the market and income based valuations.  The cost approach is primarily useful when there is a lack of market activity limiting the effectiveness of market and sales comparison approaches.  The Cost Approach also aids in determining depreciation values for physical deterioration, functional or external obsolescence.

What factors are taken into consideration?

The Cost Approach will require a higher degree of detail about a property than typically needed for sales comparison or income based valuations.  A few of the data needs include:

  • Square footage of the property broken down by usage (office, warehouse, R&D, manufacturing etc)
  • Ceiling height is warranted to ensure the cost is accurately accounted for
  • Manufacturing floors tend to have thicker areas for special equipment this information is warranted
  • Square footage with sprinkler system/HVAC coverage
  • Year Built
  • Deferred Maintenance

The cost approach begins with the determination of site value. Sales of vacant land with similar zoning, utility, and acquired for the same or similar use as the subject property being appraised, are analyzed.  In markets where site sales are limited, other site sales of varying property type may be considered as long as they have core similarities in legally acceptable use.

Once site value has been determined, reproduction or replacement costs of the improvements are estimated as if the improvements were new.  The estimate is then further adjusted for all elements of accrued depreciation including physical depreciation, functional and/or external obsolescence.

In the next post we will discuss the income approach to valuation.

In the meantime, if you have real estate valuation issues or questions about real estate valuation services, please contact Holly Swisher, CMI, Columbus, Ohio CPA firm Clarus Partners at hswisher@claruspartners.com or 614-256-3445.

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