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Reconciliation to Indicated Value by the Cost Approach

Instructor: Janice Chretien
The purpose of this lesson is to explain how to perform reconciliation to indicated value by the cost approach to property valuation. The cost approach formula will be explained and demonstrated.

Reconciliation to Indicated Value

Reconciliation to indicated value means to perform a second appraisal using a different method than what was performed on the first appraisal, then, considering the information of both appraisals, provide a final opinion of value.

For example, Judy wrote a contract for a home at $265,000. The lender requested an appraisal that was performed using comparable properties. The appraiser's opinion of value was $249,500.

The lender contacts the appraiser and asks for reconciliation to indicated value by the cost approach. The lender is asking the appraiser to perform an appraisal on the subject property using the cost approach, then to consider the findings from the comparable properties approach to the findings of the cost approach and make a final decision of value.

Value by the Cost Approach

The value by the cost approach calculates how much it would cost to replace (rebuild) a property. This is achieved by determining the cost to rebuild the property and subtracting the depreciated amount, which is based on the age of the home, then adding the value of the land.

The formula is:

  • value = replacement cost - depreciation + land value

The formula can be worked in five easy steps:

  1. Estimate the replacement cost of the home.
  2. Estimate the depreciation (percentage of depreciation = effective age / economic life).
  3. Subtract depreciation from the replacement cost.
  4. Estimate the land value.
  5. Add the depreciated cost of the home to the land value.

The cost approach is useful in appraisals where comparable properties are not available, since the approach does not depend on market data. However, the cost approach is considered less reliable with older homes.

Example

Joe is an appraiser for Shiny Side Appraisers. A lender that he performed a comparable properties appraisal for has asked him for a reconciliation to indicated value by the cost approach.

The subject property is a 3,200 square foot brick home on a 14,000 square foot residential lot. Joe estimated a replacement cost of $56 per square foot and the lot value of $5 per square foot. Based on his handy reference book, Joe determined that the average lifespan of a brick home is 60 years.

Let's use this information to value the property.

1. Estimate the replacement cost of the house.

  • 3,200 square feet x $56 = $179,200

2. Estimate the depreciation.

  • percentage of depreciation = effective age / economic life
  • percentage of depreciation = 60 - (60 - 7) / 60 - 7
  • percentage of depreciation = 7 / 53
  • percentage of deprecation = 13%

3. Subtract depreciation from the replacement cost.

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