Cost Approach

Based on the assumption :

BASED ON THE PROPOSITION THAT THE INFORMED PURCHASER
WOULD PAY NO MORE THAN THE COST OF PRODUCING A SUBSTITUTE
PROPERTY WITH THE SAME UTILITY AS THE SUBJECT PROPERTY.

• Value of an asset is the Amount required to replace the service

capacity of an asset (frequently referred to as the current replacement
cost)
• Cost to acquire or construct or to substitute an asset of comparable
utility adjusted for obsolescence, including physical deterioration,
functional ( technological) obsolescence, and economic (external)
obsolescence
• ASA
A procedure to estimate the current costs to reproduce or create a
property with another of comparable use and marketability
1
 Basis in RE Valuation using Cost Approach
• The cost approach is a real estate valuation
method that surmises that the price a buyer
should pay for a piece of property should
equal the cost to build an equivalent building.
In cost approach appraisal, the market price
for the property is equal to the cost of land
plus cost of construction, less depreciation.
• The principle of substitution & contribution
are the underlying principles for cost approach

2
 Applicability
This approach is useful when the property being appraised is normally of two types

1. Propertiesthat are not frequently sold and No market Comparables

are available ( MA not possible)
• Ex: Newly built house/commercial complex /industrial property

2. Property does not generate income ( IA not possible )

Ex: New construction (already explained)
Special use properties or where there is an absence of market data or activity to
support the more traditional approaches to value
Ex : Hospitals, special type of industries, highway, bridges etc)

The application of the Cost Approach must be in balance with

market conditions
Normal types for CA
Marketable – non income producing
Non Marketable – Non Income producing properties
3
 Components of Property in CA
Typically in a Cost approach to Value a property,
there are two components involved
• Land component &
• Improvements (building, other amenities)
• Land is assessed on the Principle of
Substitution &
• Buildings (Improvements on the land) on the
principle of contribution)

4
 Cost Approach - Steps
• APPLICATION OF THE COST APPROACH
1 : Estimating Site Value
2: Estimating the Replacement cost of the
Building
3 : Estimating the Accrued Depreciation
     Economic Age-life Depreciation Method.
4 : Estimating the final Value

5
 Principle of Substitution-Site
• No prudent person will pay more for a property more than the
cost to acquire it
• Prudent person means reasonable, responsible and a rational
person
In Mysore
• If a buyer can purchase in 2018 - 4BR Villa with a view in for
Rs.2.0Cr, in Bogadi Road, why would they pay Rs.2.5 Cr for a
similar house in the same neighborhood with the same view?
• Why would a renter pay Rs.25000/month for 2 BR flat in J.P Nagar
when he could rent a similar flat right down the street for
Rs.15000/month?
• For example, if there are two similar houses for sale in an area, the
one with the lower asking price would normally be purchased first.
•
6
 Principle of Substitution
• The Principle of Substitution  says that the
maximum value of a property usually is
established by the cost of acquiring an
equivalent substitute property that has the
same use, design, and income.

7
 Site Value
• A separate site valuation is absolutely
necessary in applying the cost approach. All
such sites, whether vacant or improved, must
be valued as though they were vacant and
available to be put to their highest and best
use. There are four widely used methods of
arriving at the value of a parcel of land:

8
 Methods of estimate for Site
• The Comparative Sales Method: recent sales of comparable
sites are adjusted to arrive at value.
• The Abstraction Method: start with known sale price and
subtract value of building, leaving residual amount to site
• The Land Development Method: Hypothetical subdivision is
built and sold. Revenue from sale of lots less expenses is
derived, along with corresponding calculations to arrive at
value of land. Used only with land development or
redevelopment.
• The Land Residual Method: Hypothetical building is built;
income less expenses results in net income; net income is
capitalized to estimate value. The residual income
attributable to the land is calculated and capitalized into a
value. Used with income producing properties.
9
Methods of Site Value computation
1. Abstraction Method - Site Valuation
2. Land-Development Method - Site Valuation
3. Land Residual Method - Site Valuation
4. Comparative Sales Method - Site Valuation

10
 Principle of Contribution
• “The cost approach employs the technique of
summing all the land and building
components.”
• “The principle of contribution states that the
value of a particular component is measured in
terms of its contribution to the value of the
whole property, …”
• Contribution: the incremental amount of value
contributed to the total value of a property by
any given component, as opposed to the
actual cost of the component. 11
 Theoretical Explanation
• “The cost approach employs the
technique of summing all the land and
building components.”
• “The principle of contribution states that
the value of a particular component is
measured in terms of its contribution to
the value of the whole property, …

12
 Cost of Building + Amenities
1. Method of actual accounts / Book Value
Method/ Account Method
2. Plinth area Rate/Covered Area Method
3. Method of Estimate by considering cubical
contents
4. Cost Index Method (CPWD Method)
5. Detailed Estimate Method ( QS Method)

13
 Cost Approach Terminologies
• Reproduction Cost- the estimated cost to construct, as of the effective
appraisal date, an exact replica of the building being appraised, insofar
as possible using the same materials, construction standards, design,
layout, and quality of workmanship, including all the deficiencies, super-
adequacies, and obsolescence of the subject building.
•
• Replacement Cost- the estimated cost to construct, as of the effective
appraisal date, a building with equal utility to the building being
appraised, using modern materials, building standards, design, and
layout.
•
• Historical Cost- The actual cost of constructing an improvement, at the
time it was built
•
• Reproduction cost = exact replica
• Replacement cost = similar utility 14
 Cost of Imp/bld by Accounts Method
• If the owner has maintained proper books of accounts
wherein all details are correctly mentioned duly supported
by authentic vouchers and no defects are pointed out and
the books are not rejected then the figures shown therein
have to be followed for determining the cost.
• For all the works in the building + all amenities services
complete, the complete and labour content is worked out
to check the veracity of the accounts
• This method applies only for the assessing the cost of
construction of a new building.
• If it is to assess the building + for any other valuation date,
appropriate adjustment in rates shall be made for time
correction.
15
 Cost of Imp/bld by Accounts Method
• With the quantities of materials, cross check the
accounts / ledger/journal entries
• Materials :
If the owner has produced less vouchers for some of
the materials, the same is estimated for the missed
quantities and added at the market rates
• Labour
Similarly, the quantum of labor payment is assessed
All Other items : Payments for all other items assessed
Total Cost : Material + Labour + others on the basis of
detailed produced by him and verified completely
16
 Accounts Method-adjustments
• We rarely come across such cases where the assessee
submits complete technical accounting along with
justification statements of materials and labour.
• Such cases appear where the owner is a professional
builder or has taken huge loans and payments made
through financial institutions. In such instances, the
VOs should be more vigilant in pointing out the items
and specifications which may have got escaped from
the assessee’s submission of facts. Such items can be
valued and added separately. However this method
yields to a near to perfect valuation, if the accounts
are correctly maintained.
17
 Unit Rate Method

For some type of buildings like

Apartments of typical unit plan, Hotels,
Hospitals, Cinema Theatres etc, the Unit Rate
Method
For these properties Cost of similar properties
may be available
For ex :
50 apartment Complex
50 room Hotel
100 bed hospital
750 seat Cinema Screen
18
 Unit Rate Method

Cost per Unit ( per room, per bed, per

apartment, per seat ) are calculated
= Total cost of the Building = Cost / Unit
No. Of Units
After calculating Cost / unit of existing bldgs
Replacement Cost of New proposal is calculated
By using the formula RC
= No. Pro units x Cost/unit
Here also appropriate adjustments for size,
specification and time factor shall be made
19
 Plinth area Rate

• This is a commonly used method for

determining the cost of a building by
comparing with the known cost of a building.
The cost of a building interalia depends on the
major factors –
• (i) the area and specification of the building (ii)
the cost of materials and labour.
• The first one is covered by the plinth area rate
and the second one cost index.

20
 Plinth area Rate Method

• Data for already various types of buildings

which are actually completed are available
from :
• With various Government Departments
• With Contractors/Consultants/architects
• Or other sources
• These can be grouped types and specifications
• Estimates of completed buildings can further
be subdivided into components like Building
Cost, Cost of Amenities & Services & others
21
 Plinth area Rate Method

• A statement can be prepared comprising of the following :

• Building Cost :
• Amenities :
• Extra Items :
• Other items :
• From the costs of the above, Plinth area rate for the
above items can be worked out by dividing the respective
Costs by the Plinth area for a specified Date ( Normally
PARs are available for every year as on 1.4.XX
• We derive the PAR for the different components of the
building. These rates may be termed as Standard plinth
area rates for a particular type of building with a
particular type of specifications
22
 Plinth area Rate Method

• Suitable adjustments may be made with regard to

specifications, roof height, and items of variations. The
Adjustments may be additions for superior specs and
reductions for inferior specifications. These adjustments
may be done by the Valuer based on their experience or
further calculations
• Final PAR for the Property to be valued is arrived at for a
specified date after appropriate adjustments in the
plinth area rates for variations in spec and roof height
etc is arrived at.
• Suitable adjustments for Time Value is done
• The final replacement cost of the subject property may
be computed assessed by the formula PA X PAR for the
building as on the Date of Valuation 23
 Plinth area Rate Method

• In cases where the PAR is arrived at for

Completed buildings in an particular (earlier
year), then current PAR (future year) (which is
required in the CA) suitable indexation may be
used.
• This is more appropriate when accurate
estimates for similar type of buildings are
available only in earlier years and a
comparatively important

24
 Plinth area Rate Method : EX :1

Factory building constructed : 1985:Rs.25,50,000

• What is Replacement cost of the same in 2011
• Building Cost Index with base year as 1960 : 1.00
• 1985 : 14.16
• 2011 : 142.00
Value as on 2011 = Book Value x Cost Index Factor
= Rs.25,50,00 x 142.00/14.16 = Rs.2,55,72,000/-
This method is very useful for quick appraisal
Useful to cross check the Replacement cost arrived at
by other methods

25
 Plinth area Rate Method : EX 2

Boeing repair Hangar 10,648 Sqm : 1999 : Rs.68Cr

Find the Replacement cost in 2011
Data Available : Rep Cost for Residential Building :
1999 : Rs. 8,600
2011 : Rs.18,300

Replacement Cost of Boeing Hangar : ??

= Rs. 68 Cr x Rs.18,300 = Rs. 144.70 Cr

Rs.8600
Even though the data is available for Res bldg (not a hangar)
is used, the ratio Rs.18,300/Rs.8600 indicates the price rise
in rates of construction in the locality during the 12 yrs –
The value may be approximately appropriate 26
 Plinth area Rate Method : EX 2A

The above ex can be worked with different data too:

With 1960 as Base Year Building Cost Index 1999 : 80
2011:142
Replacement Cost for the Hangar as on 1999 : Rs.68 Cr
Replacement Cost for the Hangar as on 2011: ??
= Rs. 68 Cr x 142 = Rs.120.70 Cr
80

Rep Cost as per previous method : Rs. 144.70 Cr

% Variation : 20%
These rates may be further adjusted with some more
data and average value may be taken.
27
 Cost Index Method

• Devised & used by CPWD for arriving at the Rough Cost Estimates of
Proposed buildings by CPWD across the country for admn approvals.
• First one base year is selected
• Standard Design for a type of bldg as per CPWD spec is selected
• Detailed Est is prepared for the Standard design
• Abstract Cost for the Standard building worked out for the base year
based on rates for various items as per CPWD SOR
.
• CPWD - PAR rates for New Delhi as per CPWD for different types of
buildings are available as on
• 1.1.1991 & 1.10.2007
• For different Locations (cities) Cost indices with reference to Delhi PAR
are provided in CPWD Manuals.
PAR for different types of buildings for a particular years for different
locations are calculated by the formula
PAR for a city = Delhi PAR of the yr x City index
28
 Cost Index Method

• Devised & used by CPWD for arriving at the Rough Cost

Estimates of Proposed buildings by CPWD across the
country for admn approvals.
• First one base year is selected
• Standard Design for a type of bldg as per CPWD spec is
selected
• Detailed Est is prepared for the Standard design
• Abstract Cost for the Standard building worked out for the
base year based on rates for various items as per CPWD
SOR
• Based on the Abs Estimate, the PAR for the particular type
of building for the base year is calculated using the formula
• PAR = Cost/Plinth Area
.
29
 Cost Index Method

Base year rates working are done by CPWD for

different yrs :( For New Delhi ***)
CI = 100 (Bs Yr 17.5.1955) CI =181 (15.10.1969)
CI = 100 (Bs Yr 1.01.1970) CI = 180 (26.06.1975)
CI = 100 (Bs Yr 1.10.1976) CI = 664 (31.12.1991)
CI = 100 (Bs Yr 1.01.1992) CI = 254 (01.04.2007)
CI = 100 (Bs Yr 1.10.2007) CI = 113 (01.04.2009)
CI = 100 (Bs Yr 1.04.2007) CI = 149 (01.10.2012)
For New Delhi the CI for a specific year in between the
periods, is worked out by interpolation using the formula

30
 Cost Index Method

CI for various years other than base year are worked out based on
the formula
PAR for a year = PAR for the base year x CI for the year
CI for the base Year
CI for the year vis-a- vis (base year as 100 ) is computed from the
tabular form
Based on The SOR (M & L )of New Delhi & weightage and the SOR
of base year at Delhi
For other locations, using the same tables, (SOR 1.10.2012 at New
Delhi, Weightage (common to all locations) apply the material
rates at the locations and arrive at the appropriate CI
By this method the CI for every city for any year can be computed
using the Tabular form

31
 Cost Index Method

CI for various years other than base year are worked out based on
the formula
PAR for a year = PAR for the base year x CI for the year
CI for the base Year
CI for the year vis-a- vis (base year as 100 ) is computed from the
tabular form
Based on The SOR (M & L )of New Delhi & weightage and the SOR
of base year at Delhi
For other locations, using the same tables, (SOR 1.10.2012 at New
Delhi, Weightage (common to all locations) apply the material
rates at the locations and arrive at the appropriate CI
By this method the CI for every city for any year can be computed
using the Tabular form

32
 Cost Index Method

Annexure 1 : PAR for residential & non residential buildings

Annexure 2 : Broad spec and scale of amenities for which PAR
are applicable
Annexure 3 : Rules for working out PAR from the plan & to
which PAR are to be applied
Annexure 4 : Pro-forma for calculating CI for a bldg in any part
of the country. It gives the working method to arrive at CI for
subsequent years or in other city, on the basis of CI for the
base year
CPWD data bank gives different basic rates for office building,
schools, hostels & residential buildings for the year 1992 or
2007 depending upon base year. Also it gives norms for
adjustment factors for variation in Floor ht, plinth ht,
foundation depth etc
NBO hand book also provides more details in this reg.
33
Annexure IV

34
 Ex:1 Cost Index Method

Residential Building : 1978

Actual Cost : Rs. 5,00,000
BCI for 1978 & 1997 : 125 & 1442
Base Year : 1.10.1976 – BI :100
Replacement cost for the building in 1998??
= Rs. 5,00,000 x 1442 = Rs. 57,68,000/-
125

35
 Ex:1 Cost Index Method

New Delhi
RCC framed bldg : 1.1.1992
PAR : Rs. 2810/Sqm
Calculate the PAR for a bldg in VV Nagar in 1997
CI for VV Nagar in 1997 : 139
PAR for VV Nagar bldg : Rs. 2810 x 139 = Rs.3906
100

36
 Cost Index Method

PAR rates are only for the building cost and does
not include amenities like Electrical, Sanitary,
Water supply installations + any extra items
like Compound wall, pavements, drains,
landscaping, architectural finishes etc which
are extra items
For these extra items CPWD provides guide lines
Using these, the Replacement cost for extra
items are calculated
Final Replacement Cost of bldg + = Replacement
cost of Buildings + Amenities + Extra items
37
 Detailed Estimate Method

Here the Replace method is calculated using the

detailed estimate and abstract estimate
The prevalent rates of all items as quoted in the
market are adopted
This method gives an accurate cost of
construction
This is worked out based on the rates of the
relevant year
Final Replacement Cost is worked out

38
Depreciation

39
 Economic Life
• THE PERIOD OF TIME OVER WHICH
IMPROVEMENTS TO REAL ESTATE CONTRIBUTE
TO PROPERTY VALUE.
• REMAINING LIFETHE ESTIMATED PERIOD
DURING WHICH IMPROVEMENTS CONTINUE
TO CONTRIBUTE TO PROPERTY VALUE.

40
 Economic Obsolescence
• Loss in value due to forces external to the
property
• Incurable as nothing can be done to rectify
• For land there is no loss in value normally as
supply of land is inelastic
• Like FO, EO can be measured by Comparable
Sales or RC method.
• EX : Principle of regression

41
 Economic Obsolescence
• Loss in value due to forces external to the
property
• Incurable as nothing can be done to rectify
• For land there is no loss in value normally as
supply of land is inelastic
• Like FO, EO can be measured by Comparable
Sales or RC method.
• EX : Principle of regression

42
 Depreciation
Depreciation :
• A reduction in the value of an asset over time, due in particular to
wear and tear under normal use of it.
• Loss of service value due to usage of an asset and passage of time
• USA Case Law : Broadly, depreciation is the loss, not restored by
current maintenance, which is due to all the factors, causing the
ultimate retirement of the property. These factors embrace wear
& tear, decay, inadequacy and obsolescence
• In Valuation terms : Accrued depreciation is the loss in value from
replacement or reproduction cost new due to all the causes except
depletion as on the date of valuation
Types :
1. Physical depreciation
2. Dep due to Economic obsolescence
3. Dep due to Functional obsolescence
4. Dep due to Technological obsolescence
43
 Economic age-life depreciation

 
It breaks down the component parts
of the structure into two categories
and measures physical deterioration
for each category separately.
Curable Physical Deterioration and
Incurable Physical Deterioration.

44
 Curable/Incurable Physical depreciation
• Curable Physical Deterioration: includes items
which a prudent buyer would anticipate
correcting before or shortly after taking
possession. It is termed "curable" because it
would be economically sound to correct this
physical deterioration and the buyer would be
justified in doing so. Curable items can usually
be classed as deferred maintenance. Examples
include repair or replacement of floor
coverings, repairs to broken windows,
repainting, wallpapering. The cost to cure is the
measure of the loss in value or depreciation. 45
 Curable Physical depreciation

• Curable deterioration: Refers to a form

of deterioration that's economically feasible to repair. In
other words, the increase in value exceeds the cost of
repair.
• curable physical deterioration - deferred maintenance;
applies to items in need of repair on the effective
appraisal date. measured as the cost of restoring the
item to a reasonably new condition.
• Considered curable only if the cost of correcting the
condition would be offset by an equal or greater increase
in value. must be economically feasible to cure.
• Painting is a good example of something that generally
adds more value than it costs.
46
 Curable Physical depreciation

• EX : Damaged Kitchen – broken pipes etc :

Rs.7500
(Repair Cost )
This repair will increase property value by
Rs.7500 or the cost to cure
A defect to be curable, the defect must in a poor
condition that it should be cured as on the
date of valuation

47
 Incurable depreciation

• Physical deterioration that cannot be

practically or economically corrected at
present. It must be based on the Replacement
cost of the entire structure after the cost to
cure curable components have been
deducted. Usually calculated using the
Physical life method or economic age-life
method

48
 Incurable Physical depreciation
• Incurable Physical Deterioration: applies to
items which are not yet ready to be cured and
which it is not economically sound to cure at
this time, since the cost of correcting the
condition or effecting a cure will be greater
than the anticipated increase in value. It
should be noted that correction of the
condition may well be physically or technically
possible, however, the criterion is whether it is
economically sound to cure.

49
 Incurable physical depreciation
• Incurable depreciation or obsolescence. a defect that cannot be
cured or that is not financially practical to cure; a defect in the
“bone structure” of a building.
• The loss resulting from wear and tear for which the cost of repair
would outweigh the increase in value from repair.  This includes
ALL physical deterioration not included in the "curable" category. 
Incurable physical deterioration is categorized into short-term and
long-term.  Short term includes items with an expected life shorter
than that of the building.  Long-term includes those items that
have an expected life equal to or longer than the expected
remaining life of the building.
• EX: Defects in Structural Elements that are functional –
deteriorated RCC Roof, Corrosion of steel foundation footing
• EX :It is estimated that if a specific house had a more convenient
floor plan, it would sell for an additional Rs. 10 Lakhs. This cannot
be carried out – incurable 50
 Functional Obsolescence

• Curable Functional obsolescence

• Defects in the building to be corrected in the
perspective of Function/utility
• If in the replacement cost has already factored
such defects, separate deduction is not
needed
• EX : Air conditioning : Now has become a
common feature . If included in Rep Cost, no
need to deduct again

51
 Incurable Functional Obsolescence

• Incurable Functional obsolescence: A condition that

decreases the utility of the property & is economically
not feasible to cure as on the date of valuation
• A shop with old type
• Smaller span rooms with columns/ walls in the middle
• High Roof with no false ceiling
• Small Entrance doors/windows
• Requires the internal walls/columns to be removed
and extensive reconstruction to provide a column
free, elite vista
• Economically not feasible

52
 Depreciation

• Straight Line Method

D = C-S per annum

N
Total Depreciation = D x Age

53
 Depreciation

• Constant Percentage Method or Linear

Method Page 398

• DV = C ( 100 –(rd/100))^n
• DV = Depreciated Value

54
 Depreciation

• Constant Percentage Method or Linear

Method Page No: 398

• DV = C ( 100 –(rd/100))^n
• DV = Depreciated Value
• C : Replacement Cost
• r : Rate of Depreciation %
• n : Age of building

55
 Depreciation

• Sinking Fund Method : Page 399

S= r / (1+r)^n - 1
Accrued Sum A = (1+r)^m/r
Total Depreciation % = 100 ( S x A )
Total Depreciation = TD %

56
 Depreciation

• Sum of Digits Method : Page 402

• Digit = 1+n x n
2
n : Total life span in years
• Digit Sigma n : 1+n x n
2
For n =60 Digit Sigma n = 1+60 = 1830
2
Depreciation for 5 years = Sigma n X Sigma m
m is the age of the building
n is the Life of the building
57
 Depreciation

• Declining Balance Method : Page 402

• D (Rate of d /yr) = 1 – (S/C)^(1/n)

• S: Salvage Value
• C : Replacement Cost
• n : Life in years
• TD = D x Age x Replacement Cost

58
 Depreciation

• Written Down Value Method : Page 396

• Depreciated Value = C x (1-r)^m
• m : Age of the building
• r : Rate of Depreciation
• C : Replacement Cost

59
 Depreciation

• Statutory Depreciation Method : Page 403

• IT act specifies a %for different types of
buildings per annum
• Residential building 5%
• Non Residential Building 10%
• Hotel 20%
• Temporary 100%
• Cumulative over years calculated on the WDV
of the previous year

60
 Value as per Cost Approach

• Value of the building = Replacement Cost –

Depreciation
• In some depreciation formulas, directly the
Value less depreciation is Calculated. Be
careful about these formulas
• Problems : One Problem for a building. To
Calculate Various values of depreciations
under different methods
• Pls do one or two problems to become
thorough in calculations of depreciation 61