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An approach to the valuation of property based on the improvement’s reproduction cost or replacement cost. The cost approach is also called the summation approach, in that it involves adding together the building and land values, each computed separately. The primary steps are (1) to estimate the land value, (2) to estimate the replacement cost of the building new, (3) to deduct all accrued depreciation from the replacement cost and (4) to add the estimated land value to the depreciated replacement cost.
To estimate land value, the land is presumed to be vacant and ready for development. The appraiser bases value on comparisons of sales of comparable land. Although land does not depreciate, its current use and external factors affect its value.
To estimate reproduction cost, the comparative cost method is often used based on current market costs to construct buildings that are identical in design, type, size, and quality of construction. Accrued depreciation due to physical deterioration, functional obsolescence, and external obsolescence is deducted from this reproduction cost. Finally, the estimated land value is added to the depreciated cost of the building. Because most people will not pay more for a property than it would cost to acquire a similar site and erect a similar structure on it, the current replacement cost of the building plus the value of the land tends to set the upper limit of a property’s value.
Dearborn Real Estate Education
This "Word of the day" is excerpted from The Language of Real Estate, 6th Edition by John Reilly (published by Dearborn Real Estate Education, 2006 copyright). To purchase the complete book, with over 2800 key terms and definitions, or to browse through Dearborn's hundreds of other professional real estate titles, including Real Estate Technology Guide by Klein, Barnett, Reilly, click here.