With Ed Kling, MAI, MRICS
President, Real Valuation Group (RVG)
Appraisal Reports Lose When Cost Approach Overlooked
I often hear appraisers complain about using the cost approach to value real property. “It’s too time-consuming,” they mostly say, or, “It’s not really required anymore.” While those excuses may be true to a degree, if an appraiser is omitting the cost approach from a report, he or she is leaving one-third of the support for value off the table, reducing the impact of the report.
A cost approach analysis should be done any time improvements on a property are more than 50 percent of its value. Why? The cost approach will give the best detail of annual depreciation rate when trying to establish the remaining economic life of the improvement. If appropriately developed, the cost approach can help identify and quantify forms of depreciation.
For example, a functional limitation to a structure may be demonstrated as a rent loss, which can be capitalized, demonstrating a loss in value from this feature. All aspects of depreciation can be quantified by correct analysis, after revising rent losses and capitalization rates.
As a refresher, the cost approach estimates the value of the land as vacant using comparable sales, then adds it to the current cost to replace the improvements after subtracting for depreciation. It can be difficult for inexperienced or untrained appraisers to estimate depreciation. Perhaps that is the real reason it is often omitted from reports.
If you’re looking for a well-defined highest and best use opinion of value, make sure you consult an experienced appraiser, whether for lending or tax purposes. The right appraiser will provide a well-supported highest and best use – one that uses all of the most relevant approaches to determining that opinion.