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Chapter 14: Cost Approach. Cost Approach  The Cost Approach is most useful when:  Property is unique  Property is reasonably new and the improvements.

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Presentation on theme: "Chapter 14: Cost Approach. Cost Approach  The Cost Approach is most useful when:  Property is unique  Property is reasonably new and the improvements."— Presentation transcript:

1 Chapter 14: Cost Approach

2 Cost Approach  The Cost Approach is most useful when:  Property is unique  Property is reasonably new and the improvements represent the highest and best use of the site

3 Cost Approach  Value equals value of land plus value of improvements  Improvements value equals reproduction cost new less loss in value because of depreciation caused by age, wear and tear, and functional and external problems  Value must be adjusted for interests other than fee simple

4 Cost New  Reproduction cost  Best for new or nearly new improvements that represent contemporary construction methods  Replacement cost  Eliminates most forms of functional obsolescence  Reproduction cost and replacement cost may differ for older buildings.

5 Cost New  Types of costs  Direct  Indirect  Entrepreneurial profit

6 Methods of Estimating Costs 1.Comparative unit method 2.Segregated cost method 3.Unit in place method 4.Quantity survey method

7 Comparative unit method  Cost estimate derived from lump-sum unit cost base on either the square footage or the cubic footage  Construction classification  Type  Quality  Find unit cost for similar structures  Adjust for possible differences in mechanical systems, size, loading docks and so forth.  Multiply modified unit cost by the actual size of the subject structure

8 Comparative unit cost example Gross building area24,000 sqft Construction typeMasonry load Bearing walls qualityGood Number of stories2 Number of elevators1 Base building cost/sqft$64 Plus HVAC adjustment$1.04 Plus sprinkler adjustment$2.06 Adjusted unit cost$67.10 Story height multiplierx1.030 Perimeter multiplierx0.947 Adjusted unit cost$65.45 Building cost ($65.40 x 24,000 sqft)$1,570,800 Elevator55,000 Reproduction cost new$1,625,800

9 Segregated cost method  Cost of each structural component is estimated separately and summed to derive cost of total building  Often used when  The comparative unit method is difficult to apply because of an unusual design or mix of components  Lack of unit cost data  All components in the building do not represent the same level of quality

10 Segregated cost example ItemSize, sqftUnit cost per sqftCost Site preparation12,000$0.67$8,040 Foundation24,000$2.57$61,680 Frame24,000$5.47$131,280 Floor structure - 1st floor12,000$3.31$39,720 Floor structure - 2nd floor12,000$9.88$118,560 Floor cover - carpet24,000$3.70$88,800 Ceiling24,000$6.20$148,800 Interior partitions24,000$15.78$378,720 Sprinkler24,000$2.06$49,440 Plumbing24,000$3.40$81,600 HVAC24,000$4.45$106,800 Electrical/lighting24,000$4.51$108,240 Exterior wall12,480$12.77$159,370 Roof structure12,000$6.07$72,840 Roof cover12,000$1.85$22,200 Elevator24,000$2.30$55,200 Total $1,631,290

11 Unit in place method  Costs of structural components are summed to derive cost of total building  An allowance for contractor’s profit and overhead are built into the unit costs used

12 Quantity survey method  Cost of each item is identified and estimated separately, then summed  Adjustments for hours of labor, overhead and profit are added  Most accurate method  Is seldom used for the following reasons:  Time consuming  Some construction materials may not be readily visible  May be used to estimate the value of unusual components if they exist in a structure

13 Sources of cost information  Professional cost estimating companies  Actual costs of newly completed buildings  Contractor’s estimates  Appraiser’s files

14 Methods of Estimating Depreciation 1.Age life method 2.Breakdown method 3.Market extraction method

15 Age life method  Effective age  Total economic life  Remaining economic life  Modified age-life method  Deferred maintenance

16 Age-Life method example Reproduction cost new (30,000 Total economic life40 years Remaining economic life30 years Effective age10 years Depreciation %: 10/40 (25%)($142,500) Depreciation value of improvements$427,500 Contributing value of site improvements$15,000 Land value$65,000 Total value $507,500

17 Breakdown method  Physical curable depreciation  Measured as cost to cure  Physical incurable depreciation  Short-lived  Measured individually as the effective age/economic life x replacement (or reproduction) cost and summed  Long-lived  Measured as replacement cost new minus deferred maintenance and short-lived items multiplied by the effective age/economic life.

18 Breakdown method: Identify component cost Excavation and site preparation$9,600 Frame97,500 Floor structure67,200 Floor cover, office3,850 Ceiling, office13,500 Partitions, office36,000 Sprinkler40,500 HVAC warehouse21,950 HVAC, office11,700 Plumbing47,200 Electrical53,000 Exterior wall93,000 Roof cover25,000 Roof structure40,000 Total$560,000

19 Breakdown method: Deferred Maintenance Cost NewReplacement cost to cureRemainder Roof leak$25,000$3,500$21,500 Space heaters$21,950$23,5000 Total $27,000

20 Breakdown method: Physical incurable depreciation – Short- lived items Replacement cost Economic ageEffective life% DepreciationDepreciation Roof cover$21, $14,405 Floor cover$3, $962 Ceiling$13, $6,750 HVAC, office$11, $7,839 Plumbing fixtures$6, $3,250 Electrical fixtures$14, $7,579 Total$71,350 $40,785

21 Breakdown method: Physical incurable depreciation – Long- lived items Replacement cost new $560,000 Less Deferred maintenance$27,000 Less Incurable short-lived items$75,350 Total short-lived items-102,350 $457,650 Effective age8 years Remaining useful life42 years Deprciation percentage16%$73,224

22 Breakdown method  Curable functional obsolescence  Superadequacy  Deficiency  Measured as the difference between the cost to add the item today minus the cost to add the component originally  Must be less than the value added by adding or modifying the existing structure  If the deficiency results in the replacement of an existing item, any remaining value attributed to the item at this point must also be deducted

23 Breakdown method: Curable functional obsolescence Deficiency: Installation of truck-height loading dock$4,500 Original cost of installation-2,500 Loss in value$2,000

24 Breakdown method  Incurable functional obsolescence  Deficiency  Superadequacy — measured as  The extra cost of construction minus physical depreciation  The income difference between the level needed to support the superadequacy and current functional income levels capitalized by the overall capitalization rate

25 Incurable functional obsolescence  Method 1: Excess cost adjustment Incurable Functional Obsolescence: Superadequacy Exterior wall (added cost)$40,000 Less depreciation taken-6,400 Depreciation$33,600

26 Incurable functional obsolescence  Method 2: Rent loss Incurable Functional Obsolescence: Superadequacy Rent needed to support masonry construction$2.10 per sqft Market rent-1.95 per sqft Rent difference$0.15 per sqft

27 Incurable functional obsolescence  Method 2: Rent loss (continued)…  Note that in the previous example the operating expenses do not change, but the management fee is reduced by 3% of the difference. Net loss per year is [0.15(1-.03)]=$ per sqft or $4,365 per year. Assuming a cap rate of 10.5, this results in a loss in value of $41,571. Value loss$41,571 Less depreciation taken-6,400 Depreciation$35,171

28 Breakdown method  External obsolescence  Economic  Locational  Measured as the present value of the NOI lost

29 External obsolescence: Locational Market rent$1.95 per sqft Current rent-1.75 per sqft Rent difference$0.20 per sqft Note: operating expenses are identical but management fee is reduced by 3% of the difference. The net loss is [.20(1-.03)]=$0.194 per sqft or $5,820 per year. Assuming an overall cap rate of 10.5, this results in a loss in value of $55,429. The value represents total loss in property value. Since the land contributes to 20% of total value, the portion of the loss in value that can be attributed to the improvements is $55,429 x.80 = $44,343.

30 Depreciation summary Physical Deterioration Curable, deferred maintenance$27,000 Incurable, short-lived items$42,905 Incurable, long-term items$73,224 Total$143,129 Functional obsolescence Curable$2,000 Incurable$33,600 Total$35,600 External obsolescence $44,343 Total accrued depreciation $223,072

31 Summary of Final Value Estimate Reproduction cost new$560,000 Less accrued depreciation-223,072 Depreciated value of improvements$336,928 Plus contributing value of improvements$15,000 Plus land value$65,000 Fee simple value indication$416,928

32 Market extraction method  Percentage loss is extracted from market sale of similar properties  Comparable sales must be available  Difficult to apply if comparable and subject vary significantly in age, quality and/or condition  Assumes same market forces affect comparable and subject

33 Market extraction method example Sales price$1,400,000 Less land value-300,000 Less contributing value of site improvements-50,000 Depreciated value of the improvements$1,050,000


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