A registered valuer is valuing a unique heritage building with no comparable sales available. The building would cost $2.5 million to construct today, but due to its age and condition, suffers from $800,000 in physical depreciation and $300,000 in functional obsolescence. The land value is assessed at $1.2 million. What is the total property value using the cost approach?
Correct Answer
A) $2.6 million
Using the cost approach: Land Value + (Replacement Cost - Total Depreciation) = $1.2M + ($2.5M - $0.8M - $0.3M) = $1.2M + $1.4M = $2.6M. The cost approach deducts all forms of depreciation from the replacement cost new, then adds the land value to determine total property value.
Why This Is the Correct Answer
Cost approach: land + (cost new − all depreciation) = $1.2m + ($2.5m − $0.8m − $0.3m) = $2.6m.
Why the Other Options Are Wrong
Option B: $2.8 million
$2.8 million would mean total depreciation of only $900,000, less than the $1.1 million given.
Option C: $3.4 million
$3.4 million deducts only the $300,000 functional obsolescence and ignores the $800,000 physical depreciation.
Option D: $3.7 million
$3.7 million adds the land to the full $2.5 million cost without deducting any depreciation.
Deep Analysis of This Valuation Question
Depreciation in the cost approach includes physical deterioration, functional obsolescence (outdated design or layout) and external obsolescence (outside influences). All of them come off the cost of the building before the land is added back.
Background Knowledge for Valuation
For a unique heritage building with no sales evidence, the cost approach may be the only practical method. Valuers must still judge depreciation carefully, because an old building's replacement cost can far exceed what the market would pay for it.
Memory Technique
Remember 'LAND + BUILD - DAMAGE = VALUE'. Land value stays separate, BUILD represents replacement cost new, and DAMAGE represents all depreciation (physical + functional + external). Like buying a damaged car - you pay the base price minus all the damage costs.
When you see cost approach questions, immediately identify the three components: LAND (separate value), BUILD (replacement cost), and DAMAGE (all depreciation types). Always subtract total damage from build cost, then add land value.
Exam Tip for Valuation
For cost approach questions, write the formula first: Land + (Replacement Cost - Total Depreciation). Identify all depreciation types mentioned and ensure you subtract them all from replacement cost before adding land value.
Real World Application in Valuation
A registered valuer is assessing a historic courthouse for insurance purposes after earthquake damage. With no comparable heritage building sales available, they use the cost approach. They determine it would cost $3.2M to rebuild today, but the existing building has $600K in earthquake damage, $200K in outdated electrical systems, and sits on land worth $800K. Using the cost approach: $800K + ($3.2M - $600K - $200K) = $3.0M total value. This valuation helps the insurance company determine appropriate coverage levels and potential payout amounts.
Common Mistakes to Avoid on Valuation Questions
- •Adding depreciation instead of subtracting it
- •Forgetting to include land value in final calculation
- •Not deducting all types of depreciation mentioned
Related Topics & Key Terms
Key Terms:
More Valuation Questions
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Which external factor would most significantly impact property values across an entire suburb?
A valuer is assessing a unique heritage building with no recent comparable sales. The replacement cost is $2,000,000, accumulated depreciation is estimated at $400,000, and the land value is $800,000. What is the indicated value using the cost approach?
Under the Rating Valuations Act 1998, what principle must valuers follow when determining rateable values?
- → What is the primary purpose of Land Value (LV) in New Zealand rating valuations?
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A registered valuer is valuing a unique heritage building with no comparable sales. The building generates $80,000 annual rental income, but the cost to replace it would be $2.5 million, while the land is worth $500,000. If the appropriate capitalisation rate is 6.5%, which approach would likely provide the most reliable value indication?