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Using the Cost Approach for Real Estate Appraisals
Tuesday, February 6, 2018

Real estate investment is one of the biggest decisions a person makes in their life. It is not only the large amount of money that makes it a significant decision but also the emotions attached to it. People look forward to owning a house all their life and once they can, it’s crucial to be sure of every factor involved.

It’s not an easy task to evaluate real estate given the extremely unstable nature of land and property. Therefore, it is always suggested to consult a real estate appraisal company that will evaluate the property and guide the investor accordingly.

Different real estate appraisers prefer different approaches for evaluation depending on what factor they are basing the research on. For those who base their evaluation on cost use the cost approach.

Cost Approach

The cost approach is usually used to derive the approximate value of properties that have been recently renovated. Since these homes were refurbished, they are generally priced higher than the average rate. However, customers won’t pay extra money even if you have spent thousands of dollars on a home that’s in a less attractive area.

For example, a family with kids won’t buy a million dollar home in a neighborhood that doesn’t have a school nearby, no matter how fancy the house looks.

For appraising such properties, the cost approach takes both land and the building itself as two separate assets. The reason for taking them as separate assets is that the property will be evaluated on the basis of its structure regardless of how it’s been kept if the neighborhood is not worthy of the higher amount asked. The overall depreciation of the building is also calculated to present a fair estimate of its value which is then added for the overall quote

The building costs are calculated by sampling an older building for comparison with the renovated one. The structure is estimated per square foot where the cost per unit of construction is projected for each building. This cost includes a general quote of raw materials and labor used in the construction. The difference in the change in costs is adjusted and all miscellaneous costs are added to the final figure.

After estimating the building costs, depreciation is calculated which in this case refers to any change in property conditions that negatively affect the improvement on the real estate. This means that the renovation expenses made by the homeowner will be offset in favor of the depreciations costs. The depreciation factors include physical wear and tear, paint corrosion, etc. This also includes the cost of building extra baths in case the bath and bedroom ratio was impractical.

After adding together the building costs and deducting the depreciation expenses, the estimated construction cost is added to the original land value to obtain the fair market value of the property.

This approach is recommended for appraising over valued properties but is not widely used for residential estates as it’s too cost oriented.

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