Master the Art of Property Valuation: Understanding Appraisal by Summation (Cost Approach)

In the intricate field of real estate, determining the value of a property is crucial for decisions on buying, selling, and insuring properties. One of the reliable methods used for this purpose is the Appraisal by Summation, also known as the Cost Approach.

What is Appraisal by Summation (Cost Approach)?

The cost approach is a property valuation method that adds the land value to the cost of constructing a new building, then adjusts the total to account for depreciation. This process is highly meticulous, ensuring an accurate assessment based on three major components:

1. Land Value Assessment

First, determine the current market value of the land as if it were vacant. Specialist real estate appraisers often use detailed comparable sales data from nearby properties to arrive at this value.

2. Cost of Construction

Next, estimate the current cost to replace the existing building with a similar structure using modern materials and construction techniques. There are two main types:

• Replacement cost: The cost of constructing a building with the same utility using modern methods and materials.
• Reproduction cost: The cost to recreate a replica of the original building using the same methods and materials.

3. Depreciation Discussion

The final step involves accounting for depreciation, which includes physical deterioration, functional obsolescence, and economic or locational obsolescence.

Physical Deterioration

A decrease in value due to wear and tear over time.

Functional Obsolescence

Loss in value due to outdated or less functional aspects of the building when compared to current standards.

Economic or Locational Obsolescence

A fall in property value resulting from external economic factors or changes in the surrounding area.

Example of Appraisal by Summation

Assume a vacant plot costs $50,000. The current cost to construct a new building with similar specifications is $200,000. Because of some aging and wear, the building has depreciated by $30,000. The total appraisal by summation would be:

$$ Appraised Value = Cost of Land + Cost of Construction - Depreciation = $50,000 + $200,000 - $30,000 = $220,000 $$

This appraisal gives a well-rounded figure that accounts for practically all influential factors making it a widely accepted method among property appraisers.

FAQs

Q1: How does the Cost Approach differ from Market Value?

The Cost Approach appraises based on tangible costs and depreciation, while Market Value considers what a willing buyer would pay, influenced by market conditions and comparable sales.

Q2: When is the Cost Approach most effective?

This method is most effective for new constructions or properties without typical market comparables, like schools, churches, or unique custom buildings.

Q3: Can Depreciation be calculated easily?

Depreciation can be complex to calculate meticulously. Accurate measurements often require experience and sometimes consulting specific depreciation guides or hiring a professional appraiser.

Related Terms: replacement cost, reproduction cost, land value, depreciation.