Cost Approach (Replacement and Reproduction Cost, Depreciation)
The cost approach estimates value as cost new minus depreciation plus land value (for real property) or cost new minus depreciation (for personal property). Its reliability depends on depreciation being measurable and the asset being new or specialized.
Distinguish reproduction cost (cost to replicate an identical asset with the same materials and methods) from replacement cost (cost to build an asset of equivalent utility with modern materials and methods). Replacement cost is generally preferred because it reflects current technology; reproduction cost suits historic or unique assets. Know the cost-estimation methods: quantity survey, unit-in-place, comparative unit, and trend or index adjustment.
Depreciation has three components: physical deterioration (curable and incurable), functional obsolescence (deficiencies or superadequacies, curable and incurable), and external (economic) obsolescence (causes outside the asset). Curable means the cost to cure is recovered in value; incurable means it is not. Functional obsolescence is internal to the asset; external is outside it - a frequent trap when a fact pattern describes a changed neighborhood.
Worked example: replacement cost new 500,000; physical deterioration 40,000; functional obsolescence 25,000; external obsolescence 35,000; land 150,000. Value = 500,000 − 100,000 + 150,000 = 550,000. Never depreciate land, and never apply external obsolescence to land separately if it is already captured in land value.
Traps: subtracting depreciation from land; double-counting curable items in both physical and functional categories; and using reproduction cost when the asset's technology is obsolete.