Question

1. Discuss the strengths and weaknesses of the COST APPROACH

2. (a) What Principle (s) underlies the adjustment process used in the DIRECT COMPARISON APPROACH?

(b) Describe TWO METHODS an appraiser can use for estimating an adjustment

Answer 1

1. Strengths

• ​​​​​​​It is most appropriate when income approach and direct comparison approach is not applicable due to lack of comparable properties or the properties income generating data.
• Most appropriate method when the sales property is a special use building like oil refinery, museum or church.
• Its appropriate to determine the cost of building rehabilitation, modernization or remodeling of property.
• Easy to comprehend as its separates the land value, building value and any improvement or additional work

Weakness  

• It assumes the building value equals to the building cost
• It doesn't reflect the forces of supply and demand and doesn't take into account the developers profit and risk
• If the degree of depreciation is high and can't be quantified with reliability, the results obtained from cost approach is not reliable.  
• Assumes that the building would be completed and available for use at the date of valuation.

2 (a). Direct comparison approach uses principal of substitution as its basis. It means if an appraiser knows the price that was paid for a comparable property that is similar to the subject property and has been recently sold in the same neighbourhood as the subject property, the subject property should have a market value equal to that comparable property.

(b). The two methods are:

1. Percentage Adjustment: Difference with comparable expressed as a percentage.

For example, we have a comparable property which was sold for $100,000 and is 15% superior in location and 20% inferior physically to the subject property. The net adjustment to the comparable is an upward adjustment of 5%. Thus, the subject property value should be $100,000 x (1+5%) = $105,263.

2. Dollar adjustments: Difference with comparable expressed as dollars.

The net absolute difference (in dollars) between superiority and inferiority of the comparable property with subject property should be adjusted while determining the value of subject property.