Commercial Real Estate Appraisal Cost Approach

The cost approach was historically prepared as a part of most commercial real estate appraisals. But, the compunction to include the cost approach (when it was not relevant) has dissipated over the last 20 years.

The principle of substitution is the technical basis for employing the cost approach. According to the principal of substitution, a prudent buyer would not pay more than the cost to build a like material goods. In other words one would not spend $2,000,000 to buy a new apartment complex if they could build it for 1,500,000.

The cost approach value is the sum of the market value of the land, depreciated replacement cost and entrepreneurial try. Land is typically Valued using the sales evaluation approach. The replacement cost is the cost to build a building of the same quality and functional utility as the subject material goods. (Reproduction cost is the cost to build an exact duplicate. This approach is used occasionally for ancient buildings built using materials and or types of craftsmanship not currently used.)

External obsolescence occurs when circumstances outside the subject material goods’s boundaries negatively impact its value. For example, an office building in New York would suffer from external obsolescence if Manhattan office occupancy fell from 93% to 75%. A mansion built next to a slaughter-house is another example of external obsolescence.

Entrepreneurial profit is the quantity of compensation necessary to induce a name to organize the site, investors, debt, architecture, construction and leasing necessary to plot and build a material goods. The appropriate quantity of entrepreneurial profit depends on factors such as competition, the problem of the project, market conditions and the wisdom of the developers plot. In some cases external or functional obsolescence prohibit entrepreneurial profit.

Following is a summary of the cost approach:

Market Value of Land
+ Replacement cost new of improvements
– All forms of depreciation
+ Entrepreneurial Profit
= Market Value via the Cost Approach
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To obtain more information on O’Connor & Associates cost approach analysis services, call us at 713-686-9955.

The appraisal division of O’Connor & Associates is a national provider of investment real estate appraisal services including commercial real estate appraisals, occupant representative brokers, private bond activity
business appraisal, gift tax valuations, insurance appraisal, highest and best use analysis, feasibility studies, condemnation appraisals, due diligence, residential appraisals and investment hypotheses.