A registered valuer is conducting a cost approach valuation on a 15-year-old commercial building. The replacement cost new is $2,000,000, and the total depreciation is estimated at 25%. The land value is $800,000. What is the total property value?
Correct Answer
A) $2,300,000
Using the cost approach: Depreciated building value = $2,000,000 × (1 - 0.25) = $1,500,000. Total property value = Land value + Depreciated building value = $800,000 + $1,500,000 = $2,300,000. The cost approach is particularly useful for newer or special-purpose properties.
Why This Is the Correct Answer
Depreciated building value = $2,000,000 × 0.75 = $1,500,000; adding the $800,000 land gives $2,300,000.
Why the Other Options Are Wrong
Option B: $2,200,000
$2,200,000 deducts 30% depreciation ($600,000) instead of the 25% ($500,000) given.
Option C: $2,500,000
$2,500,000 implies a building value of $1,700,000, which is only 15% depreciation.
Option D: $2,800,000
$2,800,000 adds the land to the full replacement cost and ignores the 25% depreciation.
Deep Analysis of This Valuation Question
The cost approach assumes a buyer would pay no more than the cost of acquiring land and building an equivalent, less the loss in value from age and obsolescence. Depreciation is deducted from the building only, never from the land.
Background Knowledge for Valuation
The cost (or summation) approach adds land value to the depreciated replacement cost of the improvements. It suits newer buildings and special-purpose properties with few sales, and is often used as a check on other approaches.
Memory Technique
Remember 'LAND + BUILD = VALUE' where BUILD = Replacement Cost × (1 - Depreciation Rate). Think of it like buying a used car: you pay for the 'land' (the registration/title) plus the 'build' (the car's current value after depreciation from new).
When you see cost approach questions, immediately identify the three components: Land value (stays the same), Replacement cost new (the starting point), and Depreciation rate (reduces building value). Apply the formula: Land + (Replacement Cost × (1 - Depreciation)) = Total Value.
Exam Tip for Valuation
For cost approach questions, always separate land and building values. Calculate depreciated building value first by multiplying replacement cost by (1 minus depreciation rate), then add land value. Double-check your depreciation calculation - 25% depreciation means the building retains 75% of its value.
Real World Application in Valuation
A registered valuer is assessing a 10-year-old medical centre for mortgage security purposes. Comparable sales are limited due to the specialized nature of the building. Using the cost approach, they determine it would cost $1.5 million to build today, estimate 20% depreciation due to wear and functional changes in medical practice, and value the land at $400,000. The final valuation of $1.6 million ($1.5M × 0.8 + $400K) provides the lender with a defensible value based on replacement cost principles.
Common Mistakes to Avoid on Valuation Questions
- •Adding full replacement cost without deducting depreciation
- •Applying depreciation to both land and building values
- •Confusing depreciation rate with remaining value percentage
Related Topics & Key Terms
Key Terms:
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