Question

"Of the three basic steps in the cost approach to valuation—estimate replacement cost, estimate accrued depreciation, and estimate site value—which is generally the most difficult and why?"

Answer 1

Solution:

Cost approach to valuation of real estate consist of three main parts

a) Replacement Cost

b) Accrued Depreciation Value

c) Land Value i.e. Site Value

Value of the Property = Replacement Cost – Accrued Depreciation + Site Value

Lets discuss each of these in brief.

Replacement Cost: Cost in today dollars of constructing the similar structure with all its specifications , designs, layouts, materials etc

Accrued Depreciation: It is loss in the value of building and/or its improvement from new to the current stage. This loss arises due to three factors, namely, physical, functional and economic.

Physical depreciation is about wear and tear of the building due to aging. Functional depreciation is due to change in consumer tastes and liking over a period of time. Economic Depreciation is related to external environments such as recession in the area, pollution etc.

Site Value :  Value of the land on which the property is built.

Of the above three, Accrued Depreciation is very subjective and hence appears difficult to determine easily. Also, the complexity in determining the accrued depreciation increases and the property ages.

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