Cost approach is the process of estimating the value of a property by adding to the estimated land value the appraiser's estimate of the replacement cost of the building, less depreciation. The replacement cost of improvements is the cost to replace an improvement with another improvement having the same utility.
Basically, how much would it cost for a brand new replacement?
This is most commonly used to appraise special-purpose properties such as libraries, schools, and police stations. You want to use it for these types of buildings because there are no comparables in the area for buildings like these, therefore nullifying the market data approach. Also, they are not designed to bring in income, thereby nullifying the income approach or the use of a gross rent multiplier.
Cost approach sets the upper limits of value because essentially you are looking at what it costs to replace a building brand new.
This approach is most appropriate for the appraisal of new property, not old. This is because the older the building is, the more variables there are for estimating its value. If something was built yesterday, then that cost of how much it cost to build is much more accurate.
If you had to appraise a property from 1910, you would be using the current cost of reproduction; the cost it took to build it in 1910 would not be a factor.
The methods for estimating the cost of construction are:
1. Unit-in-place method
Unit-in-place calculates the added cost of single units installed.
2 Square footage method
The square footage method utilizes exterior dimensions to calculate the cost per square foot.
3. Quantity survey method
Quantity survey calculates the cost of labor and materials to construct each component of a building. It is very accurate but time-consuming.