This document provides an overview of the cost approach for estimating property values. It discusses the applications and limitations of the cost approach. The key steps are estimating the land value, determining the replacement cost of improvements using various methods, deducting depreciation, adding entrepreneurial incentive if applicable, and estimating site improvement values. The total value is calculated by adding the land value, depreciated improvement value, incentive, and site improvements. The document provides detailed explanations of each step in the cost approach valuation process.

1. Unit 11: Cost Approach: Estimating Cost of
Improvements

2.  Overview of the Cost Approach
• Applications of the Cost Approach
o Appraising new properties
o Appraising properties with unique improvements
o Appraising special use properties
o Appraising properties that cannot be analyzed using the other
approaches to value, i.e. not enough comparables and no
income produced
• Limitations of the Cost Approach
o Appraising properties with older improvement
o Appraising properties in a market with minimal land value
indicators
o Appraising properties that are not at their highest and best use
o Accrued depreciation is the difference between the cost to
replace the property and the property’s current appraised value.

3.  Steps in the Cost Approach
• Steps Appraisers Use When Applying the Cost Approach
o Estimate the value of the land of the subject property as if
vacant and available to be put to its highest and best use.
o Estimate the replacement (or reproduction) cost new of the
building, as of the effective date of the appraisal.
o Estimate and deduct the amount of accrued depreciation
from the replacement (or reproduction) cost new of the
building(s).
o Add entrepreneurial incentive, when appropriate.
o Estimate “as-is” value of additional site improvements, if
necessary.
o Add the land value estimate, the depreciated value of the
improvements, the entrepreneurial incentive, and the value
of the site improvements together to arrive at the total
property value.

4.  Steps in the Cost Approach (continued)
• Estimate Value of the Land
o Six Methods Commonly Used To Estimate the Value of
Land
 Sales comparison method
 Allocation method
 Extraction method
 Land residual method
 Ground rent capitalization method
 Subdivision development method
o Sales Comparison Method
 The sales comparison method is the most commonly used
method for valuing land and is preferred over the other
methods.

5.  Steps in the Cost Approach (continued)
• Estimate Value of the Land
o Allocation Method
 The allocation method is based upon the principle of balance
as well as on the concept of contributory value.
o Extraction Method
 The extraction method (or abstraction method) is a variation
on the allocation method and is based on the same
principles.
o Land Residual Technique
 The land residual technique is based upon the premise that
the income of a property is generated by both the land and
the improvements, and that there is a relationship between
the income a property produces and the value of that
property.

6.  Steps in the Cost Approach (continued)
• Estimate Value of the Land
o Ground Rent Capitalization Method
 In the ground rent capitalization method, the annual
ground rent is divided by a market derived capitalization
rate.
 Ground rent is the rent that is payable under a ground
lease, which is a long-term lease (sometimes up to 99
years).
o Subdivision Development Method
 The subdivision development method (or land
development method) is used to value land when
subdivision and development of the subject site represent
the highest and best use of the property and sales
information for finished lots is available.

7.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Reproduction vs. Replacement
 Reproduction Cost
• Reproduction cost is the dollar amount required to
construct an exact replica of the property being appraised.
• This cost estimate assumes the cost of using like kind and
quality of materials, identical construction and
workmanship standards, as well as identical design and
layout.
 Replacement Cost
• Replacement cost is the dollar amount required to
construct improvements having the same utility and quality
as the subject property using current construction
materials, methods, and techniques.

8.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Sources of Data
 Building Area
• The American National Standards Institute (ANSI) has developed a
standard method for calculating floor areas in single-family dwellings.
 Construction Costs
• Appraisers rely on reliable cost data in order to formulate the cost
approach. As such, gathering and identifying this information is
essential.
• Examples of Direct Costs
o Building materials, products, and equipment used in construction
o Labor used to construct the building(s)
o Contractor’s profit and overhead, including both project and worker
supervision, worker’s compensation, fire, liability, and
unemployment insurance, as well as performance bonds
o Equipment rental, including an on-site temporary office, material
storage facilities, security fencing, barricades, and portable toilets
o Temporary power, water, phone service, and utility costs
o Security, including guards and video monitoring
o Temporary construction easements

9.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Sources of Data
 Construction Costs
• Examples of Indirect Costs
o Professional fees
o Environmental and building permit fees including plan check
fees
o Building construction inspector fees
o Zoning change, conditional use permit, and environmental
consultant’s fees
o Accounting, legal, and appraisal fees
o Financing fees
o Lease-up, marketing, and sales costs, including
commissions, sales incentives, and administrative costs
o Escrow, title insurance, and recording fees
o Insurance and property taxes during construction

10.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Methods Used to Estimate Cost
 Introduction
• The index method and the comparative unit method are the
quickest and easiest to calculate.
• The unit-in-place method is a more in-depth cost estimate
that provides more detail than the square-foot or index
method.
• The quantity survey method is the most in-depth and detailed
of the commonly used processes for estimating costs, but it
also is the most time-consuming and arduous of the four.
 Index Method
• Cost-index trending involves converting known historical costs
into current cost estimates.

11.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Methods Used to Estimate Cost
 Comparative Unit Method
• The comparative unit or square-foot method is based on
costs of similar structures computed on a unit of
measurement.
• The two units of measurement that are most commonly
used are square foot and cubic foot.
o A square foot is an area equal to one foot by one foot
square.
o A cubic foot is a measurement for volume. It is an area
one foot long, by one foot wide, by one foot high.

12.  Steps in the Cost Approach (continued)
• Estimate Replacement (Reproduction) Cost
o Methods Used to Estimate Cost
 Unit-in-Place Method
• The unit-in-place method is an accurate way to calculate
building costs since every building component must be
identified.
 Quantity Survey Method
• The quantity survey method is the most thorough and
accurate method of estimating building costs. It is also the
most time-consuming and intricate method.

13.  Steps in the Cost Approach (continued)
• Estimate Entrepreneurial Incentive
o Entrepreneurial incentive represents the amount an
entrepreneur expects to receive for his or her contribution to a
project and risk.
o Entrepreneurial profit is the compensation the owner or
developer actually receives from the undertaking.
• Estimate Value of Site Improvements
o Items like landscaping, sprinkler systems, driveways, brickwork,
fences, etc. fall into the category of site improvements.
o For some properties, the contribution of site improvements to
value is negligible.
o In other situations, it is significant. Appraisers use market data
to determine the “as-is” value.
o This method is used because the cost to install site
improvements does not necessarily equal the value they
contribute to the site.