The Cost Approach

The Cost Approach is the second approach an Appraiser can use in making a determination of value. There are two ways to determine the cost: reproduction cost or replacement cost. Reproduction is the exact replication of the house using the same materials, etc. Replacement is the cost to replace the house using today’s materials, etc less accrued depreciation.

The replacement cost is the analysis most frequently performed. The reproduction cost is usually for specific cases. We will dicuss only the replacement cost in this post.

Fannie and Freddie don’t require the cost approach and FHA doesn’t require it if the house is new construction or is less than a year old. In today’s market Lenders are more often than not requiring this approach be completed regardless.

Essentially this approach analyzes the replacement cost of the house considering its current age. It breaks down the line item costs and depreciation of a property first by separating out the land. An opinion of value of the land is determined without the improvements.

The cost of the improvements are then calculated using a cost service such as Marshall & Swift or consultations with builders, et al. The Appraiser considers the quality of the construction and the various improvements (house, garage, screen porches, etc) and calculations are made to determine their values.

The aged-life depreciation method is used to determine the amount of depreciation for the effective age of the house. Effective age simply put is the depreciated age of the house and improvements – resulting in an age that the house is at this point in time. This number is subtracted from the total life expectancy of the house. The value of the land is added back into the depreciated cost of the improvements and the replacement cost is the result.

The replacement cost is then compared to the sales comparison value to determine if there is a reasonable variation. This gives the Appraiser a basis to double check to determine if the opinion of value is justified.

 

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