The cost approach estimates the replacement value of property by analysing the costs of its components. It lies somewhere between the inferred and the intrinsic method, and is generally not regarded as a reliable and accurate valuation technique for current values.
Value is calculated by adding the free market value of land (as if vacant) to the reconstruction cost of the building, minus the depreciation suffered over the years in comparison to a new building.
So, a simple example would be as follows:
|Market Value of Land||£100, 000|
|Replacement cost of the building||+||£500, 000|
|Depreciation||–||£ 75, 000|
|Total Value of Property||=||£525, 000|
+ Sets the value at the actual cost of the property to rebuild.
– Neglects both market and value in use.
– Neglects the difference between cost and value, namely that one property might be cheaper than another but generates a much higher net income.
– Does not account for intangible factors, such as desirability of location, good school catchment areas, etc.