Replacement Cost Appraisals
Colorado Appraisal Consultants provides appraisals for a variety of replacement cost and insurance purposes. We provide replacement cost appraisals for both buildings (real estate) and equipment (FF&E).
Sometimes our replacement cost analyses are included in a market valuation appraisal, other times we are engaged specifically to provide only the replacement cost value.
Replacement costs can be estimated for the building only (building improvements), the site improvements only, or a combination of both, which is most typical. Typically, insurance companies only cover the building.
Replacement cost can be relevant for a variety of situations, such as:
1. Value of the improvements for flood zone improvements- If the property is located in a flood zone, many jurisdictions in Colorado state that improvements to a property can only be made up to 50% of the actual value of the improvements, as established by the Assessor, or 50% or the value of the improvements as established by a Certified Appraiser. In this case, the value of the improvements generally means the depreciated cost of the building and site improvements. Some jurisdictions state fairly vague language that indicates the “value of the improvements”, without defining whether or not site improvements are included. We interpret this to mean the value of the building and site improvements, though this could change.
2. Insurable Value– For insurance purposes, generally, the insurable value of the property is the replacement cost new of the building improvements only, with no land value, depreciation or site improvements. Developer profit is also not included.
3. HOA requirements- Most HOA’s require that the full replacement cost of the complex be re-evaluated every so often. Unless otherwise stated, we typically include the replacement cost new of the building improvements only, with no depreciation, developer profit or land value.
4. Market Value- One indicator of value for a new/proposed building or development is the replacement cost new, minus any depreciation (if applicable), plus land value.
Replacement Cost (New)
Replacement cost new generally refers to the full replacement cost of the improvements, in today’s dollars, without inclusion of depreciation or land value. The cost analysis is based on constructing a similar replica of the improvements, not an exact replica, which would be referred to as the reproduction cost. Replacement costs can be for the building only, or for the building and site improvements.
The Dictionary of Real Estate Appraisal, 5th Edition, published by the Appraisal Institute, defines Replacement Cost (New) as:
“A replacement cost estimate envisions constructing a structure of comparable utility, employing the design and materials that are currently used in the market. The current cost of a similar new item having the nearest equivalent utility as the item being appraised. The cost of replacing an asset with an equally satisfactory substitute asset; normally derived from the current acquisition cost of a similar asset, new or used, or of an equivalent productive capacity or service potential. Replacement cost assumes the use of modern materials, techniques, and designs.”
Reproduction Cost (New)
The Dictionary of Real Estate Appraisal defines reproduction cost as:
“The cost to create a virtual replica of the existing structure, employing the same design and similar building materials. The current cost of an identical new item. In the market for fine art, reproduction cost is equivalent to the cost of creating a facsimile of the original item.”
Applicability of Replacement Cost vs. Reproduction Cost
In almost all appraisal situations, replacement cost is the most applicable cost analysis. In specialized litigation or historic building appraisals, reproduction cost can be applicable. Reproduction cost, however, is much more difficult to support (if supportable at all) and is not relevant to a current value of the building.
The Dictionary of Real Estate Appraisal defines the Cost Approach as:
“One of the approaches to value commonly applied in Market Value estimates and many other valuation situations. A comparative approach to the value of property or another asset that considers, as a substitute for the purchase of a given property, the possibility of constructing another property that is an equivalent to the original or one that could furnish equal utility with no undue cost resulting from delay. The Valuer’s estimate is based on the reproduction or replacement cost of the subject property or asset, less total (accrued) depreciation. The cost approach establishes the value of a real property by estimating the cost of acquiring land and building a new property with equal utility or adapting an old property to the same use with no undue cost due to delay. An estimate of entrepreneurial incentive or developer’s profit/loss is commonly added to land and construction costs. For older properties, the cost approach develops an estimate of depreciation including items of physical deterioration and functional obsolescence.”
Some replacement cost analyses require that land value, depreciation, and/or developer profit are strictly excluded. These items are not typically included for insurance purposes.
If the cost approach is developed as one of the three valuation methods utilized for a market valuation of the entire property (land and building), these items are included.
Depreciated Value of the Improvements
The depreciated value of the improvements refers to the replacement cost new of either the building (building improvements), the site improvements, or a combination of both, minus depreciation. Typically, developer profit and all soft costs are included in the replacement cost new and are thus depreciated along with the building and site improvements. The rationale being that these costs are necessary to develop the building/property and are no more separable than the labor utilized to frame the property.
Depreciation is a separate topic. A summary is below.
Depreciation may be defined as any loss of value from any cause. There are three general areas of depreciation: physical deterioration, functional obsolescence and external obsolescence. Depreciation may be curable or incurable. If the depreciation costs more to fix than the value gained, the depreciation is considered incurable. If the depreciation costs are equal to or greater than the value gained from remedying the depreciation, it is considered curable. The three types of depreciation are further described as follows:
This results from deterioration from aging and use. This type of depreciation may be curable or incurable. Typically, depreciation of long-lived items (major building components such as the foundation, frame, etc.) is considered incurable. Deferred maintenance and short-lived items are considered curable.
This results from a lack of utility or desirability due to design or market perception of the improvements. This type of depreciation may be curable or incurable.
This is due to circumstances outside the property itself, such as surrounding redevelopment, market conditions, industry, demographic and economic conditions or an undesirable proximate use. This type of depreciation is rarely curable.
In most appraisal situations, the building value is the depreciated cost of the building. This is found by estimating the replacement cost new, minus depreciation. In this case, developer profit would be included.
For more complex assignments or appraisal purposes, land values can be estimated for comparable sales (similar sales of a property with land and building), then deducted from the sale price, to arrive at the building-only value. This is one form of extraction and can also be used to provide “market derived” depreciation. The same can be done to estimate land value- deduct the estimated depreciated value of the improvements from the total sale price to arrive at the value of the land only.