The cost method of real estate valuation is a real estate valuation method that relies on estimating the cost of building, replacing, or renovating a property. This method is mainly used to value real estate that has no comparable sales in the market. such as new or newly remodeled properties.
According to international evaluation standards. The cost approach to real estate valuation is defined as:
“Estimate the present value of the expected cost of building or replacing a property. or replenish it. or its development. This cost includes all materials, labor and other expenses necessary to construct, renovate or develop the property.”
The cost method provides an indication of value using the economic principle that a buyer will not pay more for an asset than the cost of obtaining an asset of similar utility, whether by purchase or construction, unless time, inconvenience, risk, or other factors are involved. The method provides an indication of value by calculating the current cost of replacing or reproducing the asset, and then deducting depreciation and all other forms of obsolescence.
Evaluation steps using the cost method (substitution method):
- Visit the building in question and familiarize yourself with its construction and finishes.
- Know the building areas of the property being evaluated.
- Estimate the costs of the construction work by the reproduction method, and the costs must include everything necessary for the construction work on the date of the evaluation and asking people with experience in similar construction costs in the same area.
- Deductions against depreciation is taking the differences between the new and old building using physical obsolescence to calculate depreciation.
- Calculate the cost of the building in its current state by deducting the depreciation of physical deterioration and obsolescence (physical, functional and economic).
- The land is valued by the comparative method.
- Calculate the market value by combining the value of the land with the cost of the building in its current state.
The steps for evaluating using the cost method include the following:
- Data collection: The appraiser collects the data needed to evaluate the property. Like this:
- Property location, area, and description of its characteristics.
- Construction material and labor prices in the region.
- Other costs associated with building, replacing or renovating the property.
2. Cost estimation: The appraiser estimates the expected cost of building, replacing, or renovating the property. using the data he collected.
3. Reductions or increases: The evaluator may make reductions or increases to the estimated cost. This is based on factors such as: * The condition of the current property. * Property location. * Economic factors.
4. Determine the market value: After making reductions or increases. The appraiser determines the market value of the property using the cost method.
Advantages and disadvantages of the cost method:
Advantages:
- This method can be used to value real estate for which there are no comparable sales on the market.
- This method provides an accurate estimate of the market value of a property if there is an appropriate construction, replacement, or renovation cost.
Disadvantages:
- It can be difficult to collect the data needed to estimate the cost.
- It can be difficult to determine the factors that affect the market value of a property.
- This approach may be inaccurate in the absence of an appropriate construction, replacement, or renovation cost.
Factors that affect the market value of real estate:
The market value of a property depends on a number of factors. Including:
- Location of the property: The location of a property greatly affects its value. Real estate located in vibrant and active areas is more valuable than real estate located in remote areas.
- Property areas: The size of the property also affects its value. Larger properties are more valuable than smaller ones.
- Property condition: The condition of the property also affects its value. Real estate in good condition is more valuable than real estate in poor condition.
- Economic factors: Economic factors also affect the value of real estate. Rising real estate prices are associated with higher rates of economic growth.
Practical applications of the cost method:
The cost method is used to value real estate in a variety of practical applications. Like this:
- New or newly modified real estate appraisals.
- Appraise real estate for which there are no comparable sales in the market.
- Evaluate properties with defects or damage.
- Real estate appraisal
