Definition
The cost approach calculates value by estimating replacement cost of improvements plus land value, minus depreciation. It's most useful for new construction; for older properties, it's less reliable due to depreciation complexity.
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The cost approach values a property based on what it would cost to replace it, which is particularly useful for new construction, unique properties, or when comparable sales are limited. The method includes determining land value, calculating replacement cost of improvements, estimating all forms of depreciation (physical, functional, and external), and concluding to final value. This approach is less relevant for older residential properties with significant depreciation.
Pro Tip
Cost approach is reliable for new construction. For older properties, rely more on comparable sales. Cost approach might significantly overvalue older buildings.
Example
A recently constructed home is appraised using the cost approach: land value of $80,000 plus replacement cost of $350,000 minus depreciation of $5,000 equals a concluded value of $425,000.