Legal Definitions - cost approach

The cost approach is a method used by appraisers to determine the value of real estate, such as land and buildings. This approach estimates what it would cost to construct a new property that provides the same practical use and functionality as the existing one. The fundamental principle behind this method is that an informed buyer would typically not pay more for an existing property than the expense of building a brand-new, equivalent replacement. This calculation often includes the cost of the land, current construction materials, labor, and an allowance for depreciation (loss in value due to age, wear, or obsolescence) of the existing structure.

• Example 1: Valuing a Specialized Manufacturing Plant

  Imagine a company is looking to purchase an older, custom-built factory designed for a very specific manufacturing process. Because there are few similar factories recently sold in the area (making a "market approach" difficult) and the factory doesn't generate direct rental income (limiting an "income approach"), an appraiser might use the cost approach. They would estimate the current cost to acquire a similar piece of land and then build a brand-new factory with the same specialized layout, utility connections, and structural features. From this estimated new construction cost, they would subtract an amount for the depreciation of the existing, older factory due to its age and wear. The resulting figure would represent the property's value based on what it would cost to replace it.

• Example 2: Assessing a Newly Built Community Center

  A local government has just completed construction of a new community center, featuring a gymnasium, meeting rooms, and administrative offices. To determine the property's value for insurance purposes or financial reporting, an appraiser would likely employ the cost approach. They would calculate the cost of the land, plus all the expenses involved in constructing the new building, including materials, labor, architectural fees, and permits. Since the building is brand new, there would be little to no depreciation to consider, making the total replacement cost a direct indicator of its current value.

• Example 3: Appraising a Unique, Historic Landmark Building

  Consider a historic courthouse building that a preservation society wants to value for a grant application. This building is unique, rarely sold, and not typically rented out for income. The appraiser would use the cost approach by estimating what it would cost to build a modern structure that could serve the same governmental and public functions, with similar square footage and quality of construction, but using current building standards. They would then factor in significant depreciation for the age and functional obsolescence of the historic building, while also potentially adding value for its historical significance if applicable to the valuation purpose. This method helps establish a baseline value when direct market comparisons or income projections are not feasible.