Cost-based approach: the essence and main features

The main way to determine the market value of real estate, machinery and equipment is a costly approach, which is based on the principle of substitution. According to him, a person pays an unjustified price for an object, if it is higher than the one that can be paid for the same kind of utility and quality.

When real estate valuation is carried out, those approaches that allow the most accurate reflection of its value are taken into account. It is the most costly of them. It is understood that the cost of the object in this case consists of the market price of the site and those expenses that are necessary to recreate, for example, the structure in its present form.

The cost approach to real estate valuation is carried out in several stages:

1. The price of the land plot is determined, which takes into account the most correct use of it.

2. Calculate the amount that will be spent on the construction of a similar facility.

3. The amount of profit received by the entrepreneur is determined.

4. Physical, functional and external wear are deducted.

5. The final calculation of the cost of the site and construction of the building itself, which should take into account the adjustment for wear.

The cost-based approach, meanwhile, has shortcomings in use. The main one is that it takes a lot of time to determine the exact cost of a building. So, when the restoration of the old structure is being carried out, it is practically impossible to accurately determine the costs of its reconstruction and the expected wear. As for typical buildings, it is this approach that is most optimal in their evaluation, because it is very simple to use. In some situations, it is the only possible option, for example, when assessing special purpose buildings (schools, stations, power stations) or insurance value.

The cost approach is often used when assessing fixed assets, unfinished construction or analysis of the most effective use of the site.

With regard to the calculation of the cost of construction, they are conducted using four main methods: index, comparative unit, breakdown into components and quantitative survey.

So, the last survey consists in drawing up an estimate for direct costs that apply to all types of work, materials, mechanization, utilities, and so on. To these costs, the investor's profit and overhead are added . This method is considered the most accurate, but also the most time-consuming to use, because it requires the evaluator knowledge in the field of construction and budgeting.

The cost approach in real estate appraisal also uses a breakdown method, which is a bit like a quantitative one, but is not so laborious. The fact is that he uses not single, but enlarged quotations of all elements of the design.

As for the comparative unit method , its use is justified for model comparisons. So, in order to evaluate an object, it is chosen similar to it by technologies and characteristics. Selection is carried out in specialized directories. The method is the simplest and therefore has a very wide application.

The index method is that the book value is multiplied by special indices, which are approved by state standards. It is believed that this method has the lowest degree of accuracy.

The cost approach can be used in the evaluation of any real estate, but not always its application is justified. The fact is that for objects that will generate revenue, it is used very rarely, but its use in assessing embedded premises is simply incorrect.