Cost Approach to Appraisal: Understanding Reproduction and Replacement Costs, Study notes of Construction

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During the Session

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Our Objectives

 1. Explain and define the cost approach to

appraisal

 2. Understand the differences between

replacement cost and reproduction cost and

when they should be used

 3. Discuss the theories of substitution and

contribution

 4. Understand the whys and hows of the

cost approach

REPRODUCTION VS REPLACEMENT

Reproduction cost = exact replica

REPRODUCTION VS REPLACEMENT

Replacement cost = similar utility

Note: Replacement cost is what is used in NV for tax purposes

PRINCIPLE OF SUBSTITUTION

If a buyer can purchase a 2015 4BR/2BA house with a view near Lake Tahoe for $700,000, why would they pay $1,000,000 for a similar house in the same neighborhood with the same view?

Why would a renter pay $1100/month for a 2BR/2BA house when they could rent a similar house right down the street for $850/month?

OR

This is the Principle of Substitution

Principle of Contribution

Law of Increasing Return

• Pool in apartment complex in Las Vegas
• ½ bath on first floor of 2 story home
• Garage replacing carport
• Tape & texture replacing popcorn ceiling
• Update kitchen or bath
• Replace worn carpet
• Paint
• Inside laundry

Law of Diminishing/ Decreasing Return

• Large laundry building in apartment complex with w/d hookups in units
• High end remodel in a low end neighborhood
• Converting garage into living space when parking is limited (San Francisco)
• Adding a 2nd^ story in a 1 story neighborhood (over building for area/ non conformity)
• Outdoor pool in an area with mostly cold weather Under-improvement
• When something is constructed that does not take full advantage of what is allowed… Duplex when zoned for quad-plex
• Flipping a property and cleaning worn out carpet instead of replacing it
• A home with absolutely no landscaping

Find the Balance

https://www.surveymonkey.com/r/WF8G9VT

METHODS OF VALUING IMPROVEMENTS

Quantity Survey Method

Unit-In-Place Method

Square Foot Method

Cost Index Method (Factored Historical)

UNIT-IN-PLACE METHOD

• Direct and indirect costs by building component
• Estimates the cost of reproducing a building by taking the unit cost of each component part of the structure, and adding all of unit costs together.
• Uses components like the roof, foundation, walls, etc.
• 2nd most accurate method
• Segregated cost section in Marshall & Swift

SQUARE FOOT METHOD

• Cost method that uses cost data available from cost services or in cost manuals
• Multiplies area by a value from an authority source, such as Marshall and Swift.
• Best method for mass appraisal
• Also known as Cubic Foot Method and Comparative Unit Method

COST INDEX METHOD CONT’D

(FACTORED HISTORICAL)

• Uses a factor or multiplier applied against historical costs to estimate RCN
• Calculation:

Current index / prior index = multiplier Multiplier * historical cost = RCN

COST INDEX METHOD CONT’D

(FACTORED HISTORICAL)

• Example: House built 20 years ago for $80, Cost index when house was built was 1. Current cost index is 1. What is the RCN?
• Calculation: Current index / prior index = multiplier Multiplier * historical cost = RCN Multiplier: 1.40 / 1.10 = 1. RCN: 1.27 * $80,000 = $101,

4 Methods of the Cost Approach Most to least accurate

Quantity Survey Method

Unit-In-Place Method Square Foot Method

Cost Index Method (Factored

Historical)

BUILDING COSTS

There are 2 types of costs associated with building

Direct (Hard) Costs- Costs in a project that are not variable, such as labor, materials and profit.

Indirect (Soft) Costs- Variable costs, all costs other than labor, materials and profit. Costs not associated with the direct building of the project