Cost Approach
What the exam tests
Cost approach questions test whether you know when the approach applies, how to estimate cost new, and how to separate depreciation from land value.
Core rules
- The cost approach is most reliable for new or nearly new construction and special-purpose properties with limited sales.
- Replacement cost estimates current construction with modern materials; reproduction cost estimates an exact replica.
- Depreciation has three forms: physical deterioration, functional obsolescence, and external obsolescence.
- Cost approach formula: value = cost new - depreciation + site value (including site improvements).
- Age-life uses effective age divided by total economic life to estimate physical deterioration; it is a shortcut, not a substitute for observed condition.
Worked example
A 2,400-square-foot house has replacement cost new of $360,000. Physical deterioration is $36,000; functional obsolescence is $12,000 from an outdated floor plan; external obsolescence is $8,000 from a nearby commercial nuisance. Site value is $95,000, including driveway and landscaping. Value by cost approach = $360,000 - $36,000 - $12,000 - $8,000 + $95,000 = $399,000. The appraiser must ensure the site value is not double-counted in the cost new estimate.
Traps
Using reproduction cost when replacement cost is more appropriate; deducting the same depreciation twice; adding land value that already includes site improvements; using age-life without checking condition; applying the cost approach to an older home without market support.