The cost approach to value is the most widely used approach by tax assessors in the mass appraisal process. It is defined as:
Cost Approach… the cost approach is based on the principle of substitution – that a rational, informed purchaser would pay no more for a property than the cost of building an acceptable substitute with like utility. The cost approach seeks to determine the replacement cost of an improvement less depreciation plus land value.
The cost approach is used by most taxing jurisdictions for residential and commercial properties because it is relatively easy to automate. The cost approach estimates the replacement cost new of the property, or the cost to build a structure of equivalent utility (functionality) using today’s construction standards. From that an estimate of total accrued depreciation (physical, functional, external) is deducted from the cost estimate to get a depreciated replacement cost new. To that an estimate of the site (land) value is added to get an estimate of the fair market value of the property.
There are, however, some subjective elements that county appraisers frequently insert into cost approach. For example, most properties are assigned to a quality or construction class which tells the computer assisted mass appraisal system (CAMA) what level of replacement costs to use. When neighborhoods are new, typically the properties in them are put in the system with the same quality codes. Over time however, due to appeals or description updates, these quality ratings begin to change per property. Thus, you may find that your neighbor, who appealed his value last year has a quality code of “B” and your house, built by the same builder in the same year, has a quality code of “A”.
Depreciation is another important aspect of the cost approach. Usually all properties within a neighborhood are assigned to the same depreciation schedule resulting in building values depreciating at the same rate. However, the county will usually assign a condition code to each property which will alter this depreciation schedule. If you think that your property is in inferior condition compared with your neighbor’s property with the same condition rating, this may be a good point to argue when appealing your tax assessment.
Creating a cost approach to value is a daunting task if you are not in the real estate field and have never done it before. If you would like to give it a try the go-to source is Marshall & Swift. Most mass appraisal software systems use replacement cost data from Marshall & Swift (MS). Often, however, they do not get regular updates from MS and instead adjust their cost tables based on sale price data. If their median sale ratio (assessment/sale price) is 80% then they know their cost tables are generating values that are below market value. They will then adjust their cost tables up so that they generate cost approach values that are closer to market value transactions.
As a result the assessor's cost approach value may not be based on replacement cost at all, but resembles more of a sales comparison approach. However, if all properties in a neighborhood or market area are being treated the same way, and the statistics they use show that they are not over-valuing most properties, this is considered an acceptable mass appraisal method. The best way to combat the cost approach is to review your property record card line-by-line and compare it to your neighbors (competitors) property record cards. Are your quality and condition ratings fair? Are there any "desirability" or other subjective adjustments on your property but not others? Do they have the size and attributes of your building correct?
The cost approach is used so widely in mass appraisal that it is important to have an understanding of it when appealing your property value. For further assistance visit Fair Assessments.
