cost approach

A method or approach used to estimate the value of an improved property whereby the reinstatement cost of the buildings is assessed (after an appropriate allowance for depreciation), and the market value of the land is added based on comparable sales data. The land is assumed to be vacant and available for development for its existing use. This approach to the appraisal of a property is based on the presumption that a purchaser is prepared to pay the same sum for a property as he would pay to acquire a site and reproduce or build a similar alternative - the 'principle of substitution'. However, this presumption has limited validity and the method should be used as a last resort, i.e. when no other approach is considered applicable. In this respect, it may be said, "a building is worth its cost of replacement provided it is new, represents the highest and best use of the site, and provided its construction is justified by the expected return which it will produce." F.M. Babcock, The Valuation of Real Estate, p. 477 (1932). In other situations the method only represents an approximation to value; although it may be used as an alternative valuation in order to ascertain the amount at which a substitute property could be made available and, therefore, a test of the maximum theoretical amount that should be paid for a property.

When assessing the amount of just compensation payable in condemnation proceedings, the cost approach may be used when there is no comparable sales information available and no other method of appraisal is applicable to the subject property. Nonetheless, in this context the cost approach is considered to be "one of the least reliable indicia of market value." United States v. Certain Interests in Property in Champaign County, 271 F.2d 379, 382 (7th Cir. Ill 1959), cert. den. 362 US 974. Also called the 'replacement cost approach', the 'reinstatement cost approach', or the 'summation approach'. See also contractor's basis, reinstatement method of valuation^(Eng).