Ch 18 Cost Approach
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Adjustment: a factor when appraising a home that can make a home more
valuable (House that has a heat can have a +10,000 adjustment)
Unit of comparison: Sales price, price per sq ft, price for acre
Location
Age
Size Garage
-
-
190,000
190,000
190,000
3
+0
190,000
170,000
+10,000
Adj: 180,000
180,000
2
+10,000
190,000
180,000
180,000
180,000
2
+10,000
190,000
Lot means everything is ready to go for a home to be built on it
Land means that you may have to install some things so that a home can be built
When you are buying a home the first step is approval
Front end ratio: how much your debt is available with your income
Friction: the easier it is for your clients to acquire, the worse it is to try and get out
(credit card). Going for the easier choice
Separation: difference in value between land and home
Separation Valuation
o Insurance (If building burns down how much is my land worth)
o Accounting (Tax purposes, depreciation on homes, not land)
o Partial Acquisitions/Eminent domain (Gov takes 3 feet of land to make
sidewalk, how does this affect my property value?)
Point: 1%
Does cost equal value?
o No (Developer buys land 10 mil and builds prop for 40 mil, it is not only
worth 50 mil now)
o Depends on market. Sometimes materials and labor can cost a lot so you
will not be able to make profit off of development.
Cost Approach Procedure
1. Determine reproduction Cost or replacement cost
2. Building Improvements
3. Estimate Costs
a. Direct/Hard
b. Indirect/Soft
4. Site Improvements
a. Direct/Hard
b. Indirect/Soft
5. Estimate Entrepreneurial Profit & Incentive
6. Estimate Depreciation
7. Physical Deterioration
8. Functional Obsolescence
9. External Obsolescence
10. Estimate Land Value
Classes of Buildings: Based on the structure or frame of the building
- Class A: Frame comprised of structural steel columns and beams which are
fireproofed with masonry, concrete plaster, or other noncombustible material
- Class B: Comprised of reinforced concrete columns and beams with fire-resistant
construction
- Class C: Comprised of masonry or concrete with partial or full open steel, wood
or concrete frame
- Class D: Primarily combustible construction and comprised of wood or steel
studs in loading bearing walls with full or partially opened wood or steel frames
- Class S: Buildings are not combustible and comprise metal bents, columns,
girders, purlins and girts
Cost Manual Information
- Entrepreneurial Incentive: Anticipated Profit
- Entrepreneurial Profit: Amount Earned
- Two Depreciation Methods
o Age/Life
 Physical Age
 Actual age
 Effective age
 Competition from market
 Physical Life
 Actual Life Expectancy
 Economic Life
 How long will it contribute value
o Breakdown
 Components of accrued depreciation
 Physical Deterioration
 Functional Obsolescence
o Things like gold toilet, how functional is that?
 External Obsolescence
o Has nothing to do with the property itself

Ex: COVID has a 25% decrease in people
working from home so the office space is more
open now
Chapter 18 Income Approach
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-
Investment Considerations
o 3 factors
 How much income investment provides.
 How long it will last.
 Important if you are wanting a long term investment
 What is required rate of return?
o Methods
 Direct Capitalization
 One year’s income
 Rate (annual rate) R
 Yield Capitalization or Discounted Cash Flow
 Multiple year’s future cash flows
 Yield (rate over several years) Y
o Market Value
 Impersonal
 Pool of properties make up the market
o Investment Value
 Using leverage
 Returns go up when you borrow
Gross Potential Income
o Lease Types
 Flat Rental Lease
 Variable Rental Lease
 Consumer Price Index (CPI)
 Step-up, Step-Down
 Lease w/annual increase
 Percentage Lease
 Overage Lease
o Items to watch for
 Rent Concessions
 Lease Basis
 Renewal Options
 Escalation Clauses
 CPI, Stated minimum and maximum
 Escape Clauses
 Co-Tenancy
 Other
 Tenant Improvements
 TI Allowances
o Who pays?
o