Approaches to Property Value - Cost Approach
November 8th 2008 06:49 am By Web Development in India
Knowledgeable investors, lenders, and appraisers typically rely on three techniques to value properties.These three techniques are: cost approach, comparable sales approach and Income approach. We will explain the first of these three approaches.
At the application of the cost approach calculated you calculate how much it would cost to build a subject property at today’s prices, subtract accrued depreciation, and then add the depreciated cost figure to the current value of the lot.
Cost approach means that You can build a new property or buy existing one. So, replacement cost typically sets the upper limit to the price you would pay for an existing property. If you can build a new property for $ 180,000 (including the cost of a lot), then why pay $ 210,000 for an older property located just down the street? In fact, why pay for $ 180.000 that older property? It suffers (at least some) deterioration.
When calculating the cost of building new property first you need to calculate the cost in dollars per square meter. Use a figure that would apply in your area for the type of property you’re valuing. To learn the price per square meter talk to your local contractors or find a construction cost manuals. Because replacement costs correlate directly with the size and quality of buildings, an accurate measurement precedes accurate Valuation. Notice, too, that the cost of upgrades and extras (crystal chandelier, highgrade wall-to-wall carpeting, high-end Appliances or plumbing fixtures, sauna, hot tub, swimming pool, garage, carport, patios, Porches, etc.) must be figured separately and added to the cost of the basic construction.
After you calculate the cost of building estates under current prices, subtract the amount for the three types of depreciation: physical, functional and external. As a building ages (as result of physical deterioration) it becomes less desirable then the new building. As the property is exposed to weather conditions, use, and abuse, it deteriorates. To fill in a number for a building in good condition, estimate, say, 10 percent or 20 percent, if the property is really run-down, even 50 percent or greater depreciation might be warranted. Or instead of applying a depreciation percentage figure, itemize the costs of the repairs and renovations that would put the property in top condition. Unfortunately, itemized repairs do not work as well as percentage estimates, because you can not economically upgrade an eight-year-old roof, four-year-old carpeting, or a nine-year-old furnace to like-new condition.
Nevertheless, in one way or another, you figure how much the subject physically property has depreciated relative to a newly built property of the same size, quality, and features.
Next you need to review the amount of functional depreciation. Functional depreciation creates a loss of values such as outdated dark wood paneling, faulty floor plan, low-amperage electrical systems, out-of-favor color schemes, or inferior architectural design. A property may show little wear and tear (physical depreciation) but still suffer large functional obsolescence because the features of the property no longer appeal to potential Buyers or renters.
External (locational) depreciation occurs when a property fails to reflect the highest and best use for a site. Say you find a well kept little house located in an area now dotted with offices and retail stores. Zoning of the site has changed. More than likely, the house would add little or nothing to the site’s value. When someone buys the “house,” they will probably tear it down (or renovate it) to make way for another retail store or office building.
To estimate value of the lot, find a similar plot of land that were recently sold. When you sort all places note features such as size, view, topography, legal restrictions, etc,.
After you done all that (calculate a property’s construction cost as if newly built, subtract depreciation, and add value in site) you get market value. But you can not accurately measure the costs of construction, depreciation, or site value, cost approach will not give you the perfect answer. But it will give you a reference point to use with the comparative sales and income approaches.
Of course builders build only when they think they can make property that will be sold by a higher price than their costs. For this reason, the sale price is growing when construction costs are bigger then market price of new property.Why? Because due to lack of profit, builders will stop building. Then, when growing demand pushes against a scarce supply, market prices go up. Builder profits eventually return. The real estate construction cycle begins its next round. The opposite also applies. When builder fatten profits, sooner or later, they will overbuild. High expected profits lead to a surplus of new construction. Too much housing inventory brings down market values for new as well as existing properties.
Marko Lesko is the senior business advisor specialized in marketing, finance and investment. He has his personal blog Genius Solutions where you can find some of his works.
For more information about this topic visit http://www.genius-solution.co.cc/?cat=14
