While the limitations of the cost technique are apparent, frequently it is the only available approach to value. Hence the limitations must be reviewed relative to alternative appraisal approaches. If sales data are deficient and property may not be appraised under the income approach, the cost technique provides the most accurate method of valuation. Certain specific advantages of the cost technique may recommend reliance on this valuation approach.
First, the cost technique tends to be favored for the appraisal of new construction. If the building is designed with typical building features, workmanship, and materials, there is usually a close approximation to new construction cost and market value. The cost approach tends to lose accuracy for building showing substantial depreciation.
Second, the cost approach furnishes the best evidence of value for properties having little marketability, namely, public buildings, churches, and highly specialized industrial structures. While the cost technique is highly subjective, in these instances the appraiser has few alternatives to guide the market value estimate.
Third, the cost technique is appropriately used to estimate the cost of building rehabilitation, modernization, or remodeling. Here the capitalization of net income and the market approach supplement the cost approach to value.
Fourth, the cost approach tends to be reason-ably accurate if (1) the building shows a minimum of depreciation and (2) the site is developed to, its highest and best use. The cost approach to value helps in the decision-making process, for example, in comparing the projected cost of a new apartment building with its capitalized net income value. On the other hand, it would be invalid to appraise a 30-year-old single-family dwelling under the cost approach if a two-story walk-up apartment were believed to be the highest and best use. Therefore, the cost technique is adapted to the valuation of new property which shows little depreciation and represents the highest and best use of the site.
To conclude, I have written down a set of review questions:
1. Define the terms value and market value.
2. Do you agree with the assumptions implied in the term market value?
3. Why do appraisers value property according to the most probable sales price? Explain thoroughly.
4. What is meant by the phrase highest and best use?
5. What are the elements included in the narrative appraisal report?
6. Contrast the logic of the market and cost approaches to value. Explain.
7. What are the main limitations of the market approach to value?
8. In view of the advantages of the market comparison approach, what types of property would you appraise by this method?
9. Explain how you would obtain a list of comparable sales.
10. Outline the minimum information necessary for a comparable sales presentation.
11. Show by example how you would adjust real estate sales for appraisal purposes.
12. Demonstrate how you would appraise property by annual gross income multipliers; monthly gross income multipliers.
13. What is the significant difference between reproduction and replacement costs?
14. What estimating techniques would you use to appraise a single-family dwelling under the cost approach? Explain why you would not use other techniques of estimating costs.
15. Define and explain by example the three types of depreciation.
16 Explain four main limitations of the cost approach.
17. In view of the advantages of the cost approach, what types of property would you appraise under this method of valuation?