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Percent Change in Iowa Land Values by Crop Reporting District from Sept. 2010 to March 2011 (RLI)

Cost approach Basic idea is that an informed buyer won’t pay

more than the cost of constructing an equal, substitute property minus the depreciation and assuming no delay.

Market data is used to value the components of the subject property including the land.

Even though both the cost and sales comparison approaches use market data DO NOT mix the two; the cost approach uses a different methodology.

Cost approach Most applicable when:

Improvements are new and are highest and best use

Subject property has characteristics typical in the area

Subject property is a special use property Enough data to value the property components

but limited data to value the whole property

Cost approach Least applicable when:

No vacant land sales available Construction costs are hard to measure Depreciation is hard to measure Improvements are very old

Cost approach

Steps: Develop a land value opinion; vacant land in

highest and best use valued as highest and best use regardless of present use. Use similar highest and best use

Estimate reproduction or replacement costs for improvements.

Estimate amount of depreciation Subtract the depreciation from the cost estimate Total the land and building components

Format

New cost of improvements$300,000

Depreciation -175,000

Depreciated value of improvements$125,000

Value of the land$600,000

Value from Cost Approach $725,000

Land in the cost approach

Land value is the value for vacant land Unimproved is land without building or

structures Urban usually means land without a

house/structure even if there are roads, sewer, etc.

Rural unimproved doesn’t mean there aren’t fences, tile, ponds, etc. Just that there are no buildings or structures.

Why?

Example Subject property has 160 acres of pasture with fences

and stock pond Three other sales are located for $2800 an acre all with

similar fencing and water The indicated value of $2800 would include the fence

and water If an appraiser valued the land at $2800 and then added

the value of the fence and water they’d be overstating If the request was for an appraisal that valued them

separately then the other 3 sales would have to be allocated between the land and site improvements

Land The Cost approach inventories the land for the

subject property into various classes Cropland, tillable pasture, permanent pasture,

woodland, farmstead roads, ditches, etc. Vacant sales are used to estimate the values for

the various classes of land on the subject property

Values are applied to the subject WITHOUT making the plus or minus adjustments used in the Sales comparison approach (except be sure you still make the time adjustments)

Example Tillable ground:

90 + CSR Cropland A 85 – 90 CSR Cropland B

50 acres of Cropland A $8,000/ac $400,000 75 acres of Cropland B 7,500 562,000

Total tillable $962,000

15 acres of pasture $1,050 $ 15,750 5 acres of farmstead $8,000 $ 40,000 2 acres of roads/ditches 0 0 Total non-tillable $ 55,750 22 acres $2,534 TOTAL $1,017,750 147 acres $6,923

Cost approach (cont) Value of the land determined first Cost for the building;

Reproduction; cost to construct an exact replica of the existing building

Replacement; cost to construct a building with the utility equivalent to the one being appraised; using modern material, current standards, design, layout, etc.

Using either method use the date of the appraisal and with current prices

Data sources Local builders Market abstraction; based on sale of a new

building after the land is subtracted; works best with houses, not so good with rural property

Cost services; this is a group that summarizes costs for the appraiser; they provide manuals and other information to use in making the appraisal

Cost approaches Depreciation is the difference between the cost

to reproduce or replace property and its contributory value as of the date of the appraisal

Three types of depreciation to consider: Physical deterioration; Functional obsolescence Defects in design;

material, design, otherwise obsolete by current standards Sometimes this could be cured

External obsolescence; effect on value from outside property itself; traffic, odor, hazards, etc

Depreciation examples Corn used to be harvested on the ear and stored in ‘cribs’.

Today most of the cribs have been abandoned. This is an example of Functional depreciation

A modern hog confinement needs greater ventilation of the waste pits. This is an example of: Functional depreciation

Asphalt singles on the garage are starting to leak. This is an example of: Physical depreciation

A ethanol plant is located across the road. The resulting dust, traffic, etc. would cause: External obsolescence

What is an economic term for this?

Physical depreciation Two kinds of physical depreciation to remember: Curable; this is when the deterioration is

economically feasible to cure and they generally are taken care of; deferred maintenance; be sure to include all costs!

Physical incurable; this is when the deterioration either can’t be corrected or it would cost more to correct than its contributory value to the property Short lived; roof, furnace, etc. that would be replaced

some time but not at the time of the appraisal Long lived; basically the ones that will last the life of the

improvement; foundation, etc.

Estimating depreciation Economic age-life method:

Depreciation = Effective age/economic life * replacement cost Actual age is when it was built but there could have been

extensive remodeling that would change the effective age; the effective age is based on condition and utility of the structure; there are judgments that has to be made

Economic life is the time where the improvements contribute to the property value; they can be extended

Remaining economic life is time left where the improvements continue to contribute to the property value

Estimating depreciation Econ. life = effective age + remaining econ. life Effective age = Econ. Life - remaining econ. life Remaining econ. life = Econ. life - effective age

A major problem with this approach is that it groups the types of depreciation together.

Example Reproduction cost $100,000 Effective age 10 yrs Economic life 50 yrs Remaining econ. life 40 yrs. Ratio for cost 20%

Total Depreciation $20,000 Depreciated value of improv. $80,000 Land value $250,000 Value indicated by cost approach

$330,000

Modified Econ. Age/life method

The appraiser can recognize the curable items of physical deterioration and functional obsolescence by estimating the cost to ‘cure’ them.

This amount is then subtracted from the replacement costs.

The appraiser has to recognize the impact this adjustment might have on the effective age and economic life

Example of modified econ. life Reproduction cost $100,000 Minus curable items $3,000 Effective age 9 yrs Economic life 50 yrs Remaining econ. life 41 yrs. Ratio for cost (9/50) 18% RC minus the curable $97,000

Other depreciation 17,460 Total Depreciation (+ $3,000) $20,460

Depreciated value of improv. $79,540 Land value $250,000 Value indicated by cost approach (rounded

$329,500

Estimating Depreciation Market abstraction

First step is to estimate the depreciation from a sale Second step is to apply this estimate to the subject

building This works for properties either with similar

problems as the subject with respect to curable and incurable or for properties without physical curable or incurable short live items

The appraiser is trying to estimate the annual percentage depreciation from the sale and apply it to the subject

Annual Percent depreciation example

Sales price $400,000 Land value $100,000 Contributory value of improve. $300,000 Reproduction cost new (RCN) $500,000 Accrued Depreciation ($500,000 - $300,000)

$200,000 Overall percentage ($200/$500) 40% Effective age 10 Annual percent depreciation 4%/yr.

Application to the subject

Reproduction cost $600,000 Effective age 15 years Total depreciation percentage 60% Total depreciation ($600,000 * 60%)

$360,000

Contributory value of improvements $240,000 Land value $150,000 Value estimated by cost approach $390,000

Considering curable items

The market abstraction approach can also be modified to consider the curable depreciable items

Similar process

Sales price $1,700,000 Land value $100,000 Contributory value of improve. $1,600,000 Reproduction cost new (RCN) $2,875,000 Accrued Depreciation (RCN – contrib. value)

$1,275,000 Physically curable 200,000 Long lived depreciation 1,075,000 Long lived costs (RCN – curable) $2,675,000 Long lived dep. ($1,075/$2,675) 40% Effective age 20 Annual percent depreciation 2%/yr.

Reconciling the estimates

Remember that the whole purpose of this is to come up with an estimated value for the property.

We want to correlate the values indicated from the different approaches we used and to come up with a single value.

“Reconciliation is the method of bringing together all of the data and analyses into one final estimate of value.”

Reconciling the estimates

The reliability of the data is crucial, garbage in, garbage out

A wide spread in the estimates from the different approaches indicates a strong possibility there were mathematical and/or technical errors made.

In theory, all of the approaches should lead to the same estimate. But, for this you need; The markets to function perfectly The appraiser to function perfectly

Reconciling the estimates

That’s not likely to happen The market is the market and sometimes things

don’t happen the way you’d expect. I think this is especially true with land and land values

It is important to strive for perfection but don’t let that get in the way of being honest; don’t manipulate data beyond its limits; one paired sale isn’t the same as multiple and so on

At the end, don’t forget to ask yourself, if the property is really worth the value stated!