March 22 Cost approach

Report
Percent Change in Iowa Land Values by Crop Reporting District
from Sept. 2010 to March 2011 (RLI)
30%
25%
20%
15%
10%
5%
0%
C
EC
NC
NE
NW
SC
SE
SW
WC
State
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Basic idea is that an informed buyer won’t pay
more than the cost of constructing an equal,
substitute property minus the depreciation and
assuming no delay.
Market data is used to value the components of
the subject property including the land.
Even though both the cost and sales
comparison approaches use market data DO
NOT mix the two; the cost approach uses a
different methodology.
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Most applicable when:
Improvements are new and are highest and best
use
 Subject property has characteristics typical in
the area
 Subject property is a special use property
 Enough data to value the property components
but limited data to value the whole property
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Least applicable when:
No vacant land sales available
 Construction costs are hard to measure
 Depreciation is hard to measure
 Improvements are very old
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Steps:
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Develop a land value opinion; vacant land in highest
and best use valued as highest and best use
regardless of present use. Use similar highest and
best use
Estimate reproduction or replacement costs for
improvements.
Estimate amount of depreciation
Subtract the depreciation from the cost estimate
Total the land and building components
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New cost of improvements
$300,000
Depreciation
-175,000
Depreciated value of improvements
$125,000
Value of the land
$600,000
Value from Cost Approach
$725,000
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Land value is the value for vacant land
Unimproved is land without building or
structures
Urban usually means land without a
house/structure even if there are roads, sewer,
etc.
 Rural unimproved doesn’t mean there aren’t
fences, tile, ponds, etc. Just that there are no
buildings or structures.
 Why?
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Subject property has 160 acres of pasture with
fences and stock pond
Three other sales are located for $2800 an acre all
with similar fencing and water
The indicated value of $2800 would include the
fence and water
If an appraiser valued the land at $2800 and then
added the value of the fence and water they’d be
overstating
If the request was for an appraisal that valued them
separately then the other 3 sales would have to be
allocated between the land and site improvements
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The Cost approach inventories the land for the
subject property into various classes
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Cropland, tillable pasture, permanent pasture,
woodland, farmstead roads, ditches, etc.
Vacant sales are used to estimate the values for
the various classes of land on the subject
property
Values are applied to the subject WITHOUT
making the plus or minus adjustments used in
the Sales comparison approach (except be sure
you still make the time adjustments)
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Tillable ground:
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90 + CSR
85 – 90 CSR
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Cropland A
Cropland B
50 acres of Cropland A
75 acres of Cropland B
Total tillable
15 acres of pasture
5 acres of farmstead
2 acres of roads/ditches
Total non-tillable
22 acres
TOTAL
147 acres
$8,000/ac
7,500
$400,000
562,000
$962,000
$1,050
$8,000
$ 15,750
$ 40,000
0
$ 55,750
0
$2,534
$1,017,750
$6,923
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Value of the land determined first
Cost for the building;
Reproduction; cost to construct an exact replica
of the existing building
 Replacement; cost to construct a building with
the utility equivalent to the one being
appraised; using modern material, current
standards, design, layout, etc.
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Using either method use the date of the
appraisal and with current prices
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Local builders
Market abstraction; based on sale of a new
building after the land is subtracted; works
best with houses, not so good with rural
property
Cost services; this is a group that
summarizes costs for the appraiser; they
provide manuals and other information to
use in making the appraisal
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Depreciation is the difference between the cost
to reproduce or replace property and its
contributory value as of the date of the
appraisal
Three types of depreciation to consider:
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Physical deterioration;
Functional obsolescence Defects in design;
material, design, otherwise obsolete by current
standards Sometimes this could be cured
External obsolescence; effect on value from
outside property itself; traffic, odor, hazards, etc

Corn used to be harvested on the ear and stored in
‘cribs’. Today most of the cribs have been abandoned.
This is an example of
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A modern hog confinement needs greater ventilation of
the waste pits. This is an example of:
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Functional depreciation
Asphalt singles on the garage are starting to leak. This is
an example of:
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Functional depreciation
Physical depreciation
A ethanol plant is located across the road. The resulting
dust, traffic, etc. would cause:
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External obsolescence
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What is an economic term for this?
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Two kinds of physical depreciation to remember:
Curable; this is when the deterioration is
economically feasible to cure and they generally are
taken care of; deferred maintenance; be sure to
include all costs!
Physical incurable; this is when the deterioration
either can’t be corrected or it would cost more to
correct than its contributory value to the property
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Short lived; roof, furnace, etc. that would be replaced
some time but not at the time of the appraisal
Long lived; basically the ones that will last the life of the
improvement; foundation, etc.
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Economic age-life method:
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Depreciation = Effective age/economic life *
replacement cost
Actual age is when it was built but there could have
been extensive remodeling that would change the
effective age; the effective age is based on condition
and utility of the structure; there are judgments that
has to be made
Economic life is the time where the improvements
contribute to the property value; they can be
extended
Remaining economic life is time left where the
improvements continue to contribute to the
property value
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Econ. life = effective age + remaining econ. life
Effective age = Econ. Life - remaining econ. life
Remaining econ. life = Econ. life - effective age
A major problem with this approach is that it
groups the types of depreciation together.
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Reproduction cost
Effective age
Economic life
Remaining econ. life
Ratio for cost
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Total Depreciation
$100,000
10 yrs
50 yrs
40 yrs.
20%
$20,000
Depreciated value of improv.
$80,000
Land value
$250,000
Value indicated by cost approach
$330,000
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The appraiser can recognize the curable
items of physical deterioration and
functional obsolescence by estimating the
cost to ‘cure’ them.
This amount is then subtracted from the
replacement costs.
The appraiser has to recognize the impact
this adjustment might have on the effective
age and economic life
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Reproduction cost
Minus curable items
Effective age
9 yrs
Economic life
50 yrs
Remaining econ. life
41 yrs.
Ratio for cost
(9/50)
18%
RC minus the curable
 Other depreciation
17,460
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Total Depreciation (+ $3,000)
Depreciated value of improv.
Land value
Value indicated by cost approach (rounded
$100,000
$3,000
$97,000
$20,460
$79,540
$250,000
$329,500
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Market abstraction
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First step is to estimate the depreciation from a sale
Second step is to apply this estimate to the subject
building
This works for properties either with similar
problems as the subject with respect to curable
and incurable or for properties without
physical curable or incurable short live items
The appraiser is trying to estimate the annual
percentage depreciation from the sale and
apply it to the subject
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Sales price
$400,000
Land value
$100,000
Contributory value of improve.
$300,000
Reproduction cost new (RCN)
$500,000
Accrued Depreciation ($500,000 - $300,000)
$200,000
Overall percentage ($200/$500)
40%
Effective age
10
Annual percent depreciation
4%/yr.
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Reproduction cost
$600,000
Effective age
15 years
Total depreciation percentage
60%
Total depreciation ($600,000 * 60%)
$360,000
Contributory value of improvements $240,000
Land value
$150,000
Value estimated by cost approach $390,000
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The market abstraction approach can also
be modified to consider the curable
depreciable items
Similar process
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Sales price
$1,700,000
Land value
$100,000
Contributory value of improve.
$1,600,000
Reproduction cost new (RCN)
$2,875,000
Accrued Depreciation (RCN – contrib. value)
$1,275,000
Physically curable
200,000
Long lived depreciation
1,075,000
Long lived costs (RCN – curable)
$2,675,000
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Long lived dep. ($1,075/$2,675)
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Effective age
Annual percent depreciation
40%
20
2%/yr.
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Remember that the whole purpose of this is
to come up with an estimated value for the
property.
We want to correlate the values indicated
from the different approaches we used and
to come up with a single value.
“Reconciliation is the method of bringing
together all of the data and analyses into
one final estimate of value.”
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The reliability of the data is crucial, garbage
in, garbage out
A wide spread in the estimates from the
different approaches indicates a strong
possibility there were mathematical and/or
technical errors made.
In theory, all of the approaches should lead
to the same estimate. But, for this you need;
The markets to function perfectly
 The appraiser to function perfectly
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That’s not likely to happen
The market is the market and sometimes things
don’t happen the way you’d expect. I think this
is especially true with land and land values
 It is important to strive for perfection but don’t
let that get in the way of being honest; don’t
manipulate data beyond its limits; one paired
sale isn’t the same as multiple and so on
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At the end, don’t forget to ask yourself, if the
property is really worth the value stated!

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