The three approaches
Cost: land value plus what the improvements are still worth
Estimate what it would cost to build the improvements today, subtract depreciation, add the land value. Useful where nothing comparable ever sells, and unreliable wherever depreciation is a matter of opinion.
Method
The four steps
Value the land as though vacant
Using sales comparison, at its own highest and best use. The land figure is independent of what is built on it.
Estimate replacement or reproduction cost
Replacement cost is what it would cost to build a building of equivalent utility today. Reproduction cost is what it would cost to build this building exactly. Replacement is usually the right measure.
Deduct depreciation
Physical deterioration from age and wear, functional obsolescence from a design the market no longer wants, and external obsolescence from conditions outside the property.
Add the two together
Depreciated improvement value plus land value is the indication of value from this approach.
Depreciation
Three kinds, with very different reliability
Physical
Wear, age and deferred maintenance. The most objective of the three, and the easiest to support with inspection evidence.
Functional
A layout, ceiling height, column spacing or configuration the market no longer wants. A matter of judgement, and often substantial in older buildings.
External
Loss caused by something beyond the site: a declining area, a new bypass, a change in the industry the building served. Hardest to quantify and most often disputed.
Where it belongs
When the cost approach carries real weight
The approach is strongest where there is no market to compare against. Churches, schools, fire stations, grain elevators, processing plants and other special purpose buildings rarely sell, and when they do the sale usually reflects a change of use rather than the value of the existing one. For these, cost less depreciation is often the only defensible method.
It is weakest for older general purpose buildings in active markets. Where comparable sales exist, they measure what buyers actually pay, while the cost approach measures what a notional builder would spend less an estimate of how much the building has lost. Depreciation estimates on a forty year old building can vary by twenty points between competent appraisers, which is a wide range to build a compensation claim on.
Questions about the cost approach
The agency says my building is worth almost nothing because it is old
That is a depreciation conclusion, and it should be supported. Ask what method produced it, whether an effective age was used rather than actual age, and whether the building\u2019s continued use was taken into account.
Can I claim what it cost me to build
Cost is not value. Where the market would not pay what the building cost, compensation reflects what the market would pay. Where the building is special purpose and still in use, the cost approach may come close to your figure.
Should the appraisal include all three approaches
A complete report considers all three and explains why each was used or excluded. Omitting an approach without explanation is itself a weakness in the report.
Get a valuation question answered
If an offer has arrived and the number does not match what you believe the property is worth, the appraisal behind it is the place to look. Start with the pages below.