Definition
Appraisal by Summation is a real estate valuation method that calculates the value of a property by summing the land value and the depreciated value of improvements on the property. This method is often referred to as the Cost Approach, and it operates on the principle that a rational buyer will not pay more for a property than the cost to acquire the land and construct a comparable improvement on it.
Key Components
- Land Value: The value of the land determined through comparable sales or other appraisal methods.
- Replacement/ Reproduction Cost of Improvements: The cost to build a new replacement of the existing structures.
- Depreciation: The decrease in value of the improvements due to physical deterioration, functional obsolescence, or economic obsolescence.
Examples
Example 1: Residential Property
- Land Value: $50,000
- Replacement Cost of Improvements: $250,000
- Depreciation (20% physical deterioration): $50,000
- Appraised Value: $50,000 (Land) + $250,000 (Replacement Cost) - $50,000 (Depreciation) = $250,000
Example 2: Commercial Property
- Land Value: $200,000
- Replacement Cost of Improvements: $800,000
- Depreciation (10% functional obsolescence): $80,000
- Appraised Value: $200,000 (Land) + $800,000 (Replacement Cost) - $80,000 (Depreciation) = $920,000
Frequently Asked Questions
What is the difference between replacement cost and reproduction cost?
- Replacement Cost: The cost to construct a building with equal utility using modern materials and standards.
- Reproduction Cost: The cost to construct an identical replica of the subject property using the same materials and craftsmanship.
Why is depreciation factored into the cost approach?
Depreciation reflects the loss in value due to factors such as wear and tear, outdated features, or economic changes, ensuring the appraisal reflects the market value more accurately.
When is the appraisal by summation method most useful?
The summation method is particularly useful for new or relatively new properties where the cost of reproduction closely matches the market value, or in unique properties with no comparable sales data.
Related Terms
Market Approach: An appraisal method that compares the property to similar properties that have recently sold in the same area.
Income Approach: A valuation method that estimates property value based on the income it generates.
Depreciation: The reduction in the value of an asset over time due to factors like wear and tear.
Functional Obsolescence: Reduced utility of a property due to outdated design features.
Economic Obsolescence: The loss in property value due to external economic factors outside the control of the property owner.
Online Resources
- Appraisal Institute - Provides resources and education for real estate appraisal.
- The American Society of Appraisers - Offers information on appraisal standards and principles.
- Investopedia on Cost Approach - Detailed explanation of the cost approach using real-world examples.
References
- Appraisal Institute. (2008). The Appraisal of Real Estate (13th ed.). Appraisal Institute.
- Fisher, J. D., & Martin, J. D. (2008). Income Property Valuation. Dearborn Real Estate Education.
Suggested Books for Further Studies
- The Appraisal of Real Estate (14th Edition) by Marcy Elizabeth Harrison et al.
- Real Estate Principles: A Value Approach by David C. Ling and Wayne R. Archer.
- The Cost Approach to Valuation by David Hampton.
