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Commercial Real Estate Appraisal Cost Approach

Submitted on: Wed, 08 Jan 2014 05:33:30Views: 247
The principle of substitution is the technical basis for employing the cost approach. According to the principal of substitution, a prudent buyer would not pay more than the cost to build a like property. In other words one would not spend $2,000,000 to purchase a new apartment complex if they could build it for 1,500,000.

The cost approach value is the sum of the market value of the land, depreciated replacement cost and entrepreneurial effort. Land is typically Valued using the sales comparison approach. The replacement cost is the cost to build a building of the same quality and functional utility as the subject property. (Reproduction cost is the cost to build an exact duplicate. This approach is used occasionally for old buildings built using materials and or types of craftsmanship not currently used.)

External obsolescence occurs when circumstances outside the subject property's boundaries negatively impact its value. For example, an office building in New York would suffer from external obsolescence if Manhattan office occupancy fell from 93% to 75%. A mansion built next to a slaughter-house is another example of external obsolescence.

Entrepreneurial profit is the amount of compensation necessary to induce someone to organize the site, investors, debt, architecture, construction and leasing necessary to plan and build a property. The appropriate amount of entrepreneurial profit depends on factors such as competition, the difficulty of the project, market conditions and the wisdom of the developers plan. In some cases external or functional obsolescence prohibit entrepreneurial profit.

Following is a summary of the cost approach:

Market Value of Land
+ Replacement cost new of improvements
- All forms of depreciation
+ Entrepreneurial Profit
= Market Value via the Cost Approach

The appraisal division of O’Connor & Associates is a national provider of commercial real estate appraisal services including cost segregation studies, due diligence, insurance valuations, feasibility studies, financial modeling, gift tax valuations, commercial real estate appraisal, highest and best use analyses, casualty loss valuations and HUD map market studies.

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