The Cost Approach Formula for the Real Estate License Exam
One method of estimating the value of real estate is called the cost approach. You’ll need to know the formula for the Real Estate License Exam. The cost approach is based on the idea that the components of a piece of real estate, or the land and buildings, can be added together to arrive at an estimate of value, if they’re valued separately.
The cost approach is particularly useful for unique properties that have few comparable sales and for new construction. If you were asked to appraise a church for example, you may use the cost approach because it would be rare to find many sales of churches.
The formula for the cost approach is:
Replacement or reproduction cost – depreciation + land value = value
A breakdown of the steps of this method follows:
Estimate the replacement or reproduction cost of the improvement (structure).
Estimate all the depreciation of the improvement (accrued depreciation).
Subtract accrued depreciation from the reproduction/replacement cost.
Accrued depreciation is the total of all the estimated depreciation.
Estimate the land value separately.
Add the depreciated cost of the structure to the land value.
The result is the estimate of value.
Reproduction/replacement cost $200,000 – Accrued (total) depreciation – $50,000 Depreciated value of improvements $150,000 + Land value + $60,000 Estimated value $210,000
The cost approach has a lot of terminology that may be unfamiliar. Remember, most salesperson’s tests ask a lot of definition questions.