chapter 14: cost approach
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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 represent the highest and best use of the site. Cost Approach. Value equals value of land plus value of improvements - PowerPoint PPT PresentationTRANSCRIPT
Chapter 14:Cost Approach
Cost Approach The Cost Approach is most useful when:Property is uniqueProperty is reasonably new and the
improvements represent the highest and best use of the site
Cost ApproachValue equals value of land plus value of
improvementsImprovements 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
Cost NewReproduction costBest for new or nearly new improvements that
represent contemporary construction methodsReplacement costEliminates most forms of functional
obsolescenceReproduction cost and replacement cost may
differ for older buildings.
Cost NewTypes of costsDirectIndirectEntrepreneurial profit
Methods of Estimating Costs1. Comparative unit method2. Segregated cost method3. Unit in place method4. Quantity survey method
Comparative unit method
Cost estimate derived from lump-sum unit cost base on either the square footage or the cubic footage
Construction classificationTypeQuality
Find unit cost for similar structuresAdjust for possible differences in mechanical systems, size,
loading docks and so forth.Multiply modified unit cost by the actual size of the subject
structure
Comparative unit cost example
Gross building area 24,000 sqftConstruction type Masonry loadBearing walls quality GoodNumber of stories 2Number of elevators 1 Base building cost/sqft $64 Plus HVAC adjustment $1.04 Plus sprinkler adjustment $2.06 Adjusted unit cost $67.10 Story height multiplier x1.030Perimeter multiplier x0.947Adjusted unit cost $65.45 Building cost ($65.40 x 24,000 sqft) $1,570,800 Elevator 55,000Reproduction cost new $1,625,800
Segregated cost method
Cost of each structural component is estimated separately and summed to derive cost of total building
Often used whenThe comparative unit method is difficult to apply
because of an unusual design or mix of components
Lack of unit cost dataAll components in the building do not represent
the same level of quality
Segregated cost example
ItemSize, sqft
Unit cost per sqft Cost
Site preparation 12,000 $0.67 $8,040 Foundation 24,000 $2.57 $61,680 Frame 24,000 $5.47 $131,280 Floor structure - 1st floor 12,000 $3.31 $39,720 Floor structure - 2nd floor 12,000 $9.88 $118,560 Floor cover - carpet 24,000 $3.70 $88,800 Ceiling 24,000 $6.20 $148,800 Interior partitions 24,000 $15.78 $378,720 Sprinkler 24,000 $2.06 $49,440 Plumbing 24,000 $3.40 $81,600 HVAC 24,000 $4.45 $106,800 Electrical/lighting 24,000 $4.51 $108,240 Exterior wall 12,480 $12.77 $159,370 Roof structure 12,000 $6.07 $72,840 Roof cover 12,000 $1.85 $22,200 Elevator 24,000 $2.30 $55,200
Total $1,631,29
0
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
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 consumingSome construction materials may not be readily visible
May be used to estimate the value of unusual components if they exist in a structure
Sources of cost information
Professional cost estimating companiesActual costs of newly completed buildingsContractor’s estimatesAppraiser’s files
Methods of Estimating Depreciation
1. Age life method2. Breakdown method3. Market extraction method
Age life method
Effective ageTotal economic lifeRemaining economic lifeModified age-life methodDeferred maintenance
Age-Life method example
Reproduction cost new (30,000 sqft@$19/sqft) $570,000 Total economic life 40 years Remaining economic life 30 years Effective age 10 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
Breakdown method
Physical curable depreciationMeasured as cost to cure
Physical incurable depreciationShort-lived
Measured individually as the effective age/economic life x replacement (or reproduction) cost and summed
Long-livedMeasured as replacement cost new minus deferred
maintenance and short-lived items multiplied by the effective age/economic life.
Breakdown method: Identify component cost
Excavation and site preparation $9,600 Frame 97,500Floor structure 67,200Floor cover, office 3,850Ceiling, office 13,500Partitions, office 36,000Sprinkler 40,500HVAC warehouse 21,950HVAC, office 11,700Plumbing 47,200Electrical 53,000Exterior wall 93,000Roof cover 25,000Roof structure 40,000Total $560,000
Breakdown method: Deferred Maintenance
Cost New Replacement cost to cure Remainder
Roof leak $25,000 $3,500 $21,500
Space heaters $21,950 $23,500 0
Total $27,000
Breakdown method: Physical incurable depreciation – Short-lived items
Replacement
costEconomic
ageEffective
life%
Depreciation DepreciationRoof cover $21,500 10 15 67 $14,405 Floor cover $3,850 2 8 25 $962 Ceiling $13,500 10 20 50 $6,750 HVAC, office $11,700 10 15 67 $7,839 Plumbing fixtures $6,500 10 20 50 $3,250 Electrical fixtures $14,300 8 15 53 $7,579 Total $71,350 $40,785
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 age 8 years Remaining useful life 42 years Deprciation percentage 16% $73,224
Breakdown method
Curable functional obsolescenceSuperadequacyDeficiency
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
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
Breakdown method
Incurable functional obsolescenceDeficiencySuperadequacy — 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
Incurable functional obsolescenceMethod 1: Excess cost adjustment
Incurable Functional Obsolescence: SuperadequacyExterior wall (added cost) $40,000 Less depreciation taken -6,400Depreciation $33,600
Incurable functional obsolescenceMethod 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
Incurable functional obsolescenceMethod 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)]=$0.1455 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
Breakdown methodExternal obsolescenceEconomicLocationalMeasured as the present value of the
NOI lost
External obsolescence: Locational
Market rent $1.95 per sqftCurrent rent -1.75 per sqftRent 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.
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
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
Market extraction method
Percentage loss is extracted from market sale of similar properties
Comparable sales must be availableDifficult to apply if comparable and subject vary
significantly in age, quality and/or conditionAssumes same market forces affect comparable
and subject
Market extraction method example
Sales price $1,400,000 Less land value -300,000Less contributing value of site improvements -50,000Depreciated value of the improvements $1,050,000
€
Depreciated% =1−Depreciation value of improvements
Cost new of improvements