Depreciated Replacement Cost for a Cold-Store
A 6,500 sq m cold-storage facility on 1.1 ha of industrial land was built in 2004. It has specialised insulation, an ammonia refrigeration plant, 12 m clear height and 8,000 pallet positions. There is no directly comparable transaction; the plant is operating profitably, and the client needs a market valuation for secured lending. Replacement cost new is assessed as: building shell €950/sq m; refrigeration €2.6m; racking €0.8m; site works €1.2m; professional fees 10%; contingency 5%. Land value is €1.8m. The roof and insulation require €1.1m of work; the refrigeration plant is 60% through its economic life; functional obsolescence is estimated at 8% of the shell replacement cost because modern facilities have 15 m clear height; and external obsolescence is assessed at 12% of depreciated improvements because a new automated competitor has eroded margins. The client asks why the cost approach is being used at all.
1. Explain whether the depreciated replacement cost method is appropriate here and what conditions must be met for it to provide a market value indication.
Read the worked answer
When DRC is appropriate DRC is used where the asset is specialised, there is no useful market evidence of comparable sales, and the business use is viable. It is a cost-based proxy for market value: what a buyer would pay for the land plus the depreciated cost of replacing the improvements, rather than what the owner spent.
Conditions
- The replacement cost must be market-derived, not the actual historical cost.
- The asset must be replaceable and the cost reliably measurable.
- Land value must be separately supported by market evidence.
- All forms of obsolescence must be identified and measured: physical, functional and external.
- The business must be profitable enough to support the asset's use; otherwise external obsolescence must be increased.
- DRC is not value in use. It must reflect what a market participant would pay, including the risk that the plant is over-specialised.
Conclusion DRC is appropriate here because there are no direct comparables and the cold store is specialised. It should be cross-checked against profits or a going-concern indication, and it should not include the owner's business goodwill.
2. Calculate a DRC indication, showing the sequence of adjustments and explaining the treatment of each obsolescence.
Read the worked answer
Replacement cost new
- Shell: 6,500 x €950 = €6,175,000
- Refrigeration: €2,600,000
- Racking: €800,000 (check whether this is real property or tenant's plant; if tenant-owned, exclude)
- Site works: €1,200,000 Subtotal: €10,775,000
- Fees 10%: €1,077,500
- Contingency 5%: €538,750 RCN improvements: €12,391,250
- Land: €1,800,000 Total RCN: €14,191,250
Depreciation
- Physical: roof/insulation €1,100,000 + refrigeration 60% x €2,600,000 = €1,560,000 + other age-related €340,000 = €3,000,000. Depreciated improvements: €9,391,250.
- Functional: 8% x shell RCN €6,175,000 = €494,000. Balance: €8,897,250.
- External: 12% x €8,897,250 = €1,067,670. Balance: €7,829,580.
- Add land: €1,800,000.
DRC indication: about €9.63m.
Reasoning Physical depreciation reflects the actual condition and remaining life, not a simple age percentage. Functional obsolescence reflects the 12 m clear height against modern 15 m. External obsolescence reflects the competitor's impact on the business's ability to pay rent. Applying external obsolescence to land as well would be wrong unless the land itself is affected.
3. How would you respond if the owner argues that the profitable business is worth more than the DRC figure?
Read the worked answer
Value in use vs market value A profitable business may be worth more than the property because it includes goodwill, customer contracts, workforce, operating systems and the owner's know-how. Those are intangible assets, not real property. A market buyer of the building does not automatically acquire them.
Response
- Separate the real property, the plant and machinery, and the business intangible. The valuation should state what is included.
- If the business is profitable, revisit external obsolescence: the competitor may have eroded margins, but the subject may still have a secure niche. The 12% figure must be supported by evidence, not assumed.
- Consider the profits method as a cross-check if the property is a specialised trading asset. But for secured lending, the lender needs the realisable value of the property, not the business's value in use.
- If the owner argues for a higher figure, explain that value in use can exceed market value; that is not a valuation error. The excess is goodwill.
- If the plant is truly bespoke and only usable by the current business, the market value may be limited; that is precisely the risk DRC must capture.