COST METHOD OF VALUATION       

The "cost method" of valuation requires the determination of "replacement cost new" and from that amount accrued depreciation" is 
deducted to find the market value of the building. For example, the value of an industrial building can be found as follows:


 $
 
Replacement cost new:					
2 500 000
 
Expected economic life  when new:  20 years
Age: 5 years
      

Sum of digits for 20 years: = 210
Sum of digits for 5 years: = 15
Therefore, accrued depreciation 15/210 * 2 500 000 =					 
 


(178 571)
 
VALUE OF BUILDING:	2 321 429 Say				
2 32

To find the market value of land and buildings, the land value and the value of ground improvements are added to the value of the building value. The "cost method" requires proof of the accrued depreciation with sales evidence. However, if the valuer has sales evidence of the value of improvements, it is not necessary to resort to an indirect method of valuation such as the cost method. That is, the value of the building can be found directly from the sales. "Replacement cost new" is not a market transaction and although it can be analyzed from sales of new properties which represent the highest and best use of the land, it is usually determined from costs obtained from builders, owners, and contractors. A reasonably accurate assessment of cost can be found for new or modern buildings but there is large error in costing older buildings.

EXAMPLE

To determine the accrued depreciation of a 5 year old commercial building that is the "highest and best" use of the land:
 

 $
Sale price:
6 000 000
Less land value:
(2 500 000)
Less ground improvements:
(1 600 000)
Value of building:
2 900 000
Gross area of building: 2 000 square metres therefore value per square metre:
1 450
Replacement cost new per square metre: 
2 000
Therefore, accrued depreciation: 2 000 - 1 450 =
550 per square metre
Accrued depreciation as a percent of RCN:
27.5%
 
Evidence derived from a number of sales can used to determine a depreciation model showing accrued depreciation against age for similar commercial buildings. However, one can see that there is no need to use the cost method for example, in the above example, the valuer can use the sale evidence directly by stating that a comparable property to the sale property is worth $1 450 per square metre. Therefore, in Australian valuation practice, the method is only used for land uses without a market. For example, churches, service stations, hospitals, schools, ambulance stations and civic centres.

See depreciation