Property Valuation Technique

RES 451
COST METHOD (II)

CONTENT
 COST METHOD_FORMULA
 EFFECTIVE CAPITAL VALUE
 ANALYSIS OF BUILDING VALUE (COSTS)
 ANALYSIS OF LAND VALUES
 DEPRECIATION
 TYPES OF DEPRECIATION
 METHOD OF ESTIMATING DEPRECIATION
 DEPRECIATION
 APPLICATION

COST METHOD FORMULA

LAND VALUE + BUILDING VALUE- DEPREACIATION = MARKET VALUE

CAPITAL VALUE

EFFECTIVE CAPITAL VALUE

 The estimated market price of the premises assuming that they cannot be
altered structurally in any way
 They can only be used for their present mode of occupation (rebus sic
stantibus)

ANALYSIS OF LAND VALUE

Land value
 based assuming the mode of occupation
 determined using the Comparison Method
 cannot be changed and ignoring any prospective development.
 securing the evidences of transaction of similar-use properties.

Determination of Land Value

 The value of land/site is determined by assuming that the subject site is
vacant and ready to be developed as its highest and best use
ANALYSIS OF BUILDING VALUES

Determination of Building Value

 Building value determined by reference to
 the cost of reconstructing the existing building.
 If building is new, the actual cost is taken.
 If building old, age and obsolescence is taken into account.

Cost of construction (new) is:

 The current cost of construction to replace the subject building with a

comparable new building; or
 The current cost of construction to re- build a building which is the same as
the subject building.

FACTORS AFFECTING CONSTRUCTION COSTS

 Type of use- whether residential, commercial, etc

 Type of construction- pre-cast, in-situ, steel frames, conventional methods,
etc.
 Quality of material and workmanship
 Size and height
 Shape/Design
 Facilities such as alarm system, air-conditioning system, building automation
system (BAS), etc.
DEPRECIATION

In the cost method, the valuer has 2 choices in estimating the cost of construction:

 Reproduction Cost New

 Reproduction cost new presumes that the same or a very similar
physical structure would be built. This is the current cost to construct
an exact duplicate or exact replica of a building; that is the same in all
aspects - function, utility, design and finishes, etc.

 Replacement Cost New

 The essence of this method is that the hypothetical replacement
property represents the same utility as the subject property.
 This is the current cost to construct a building that is similar to a
comparable property in terms of function and utility.
 Building materials, finishes, design and layout can be according to
current standards.

BUILDING VALUE

Estimate the cost of construction:

STEP 1 -Replacement cost approach
-Substituted building approach

Estimate Depreciation
Apply a suitable factor to reflect the
STEP 2 ➢Age
➢condition obsolescence ➢advantages
and disadvantages etc of the building
LAND VALUE
Added to the valuation for the land value.
Should be the value of the land for that “mode or category
STEP 3 of use” i.e rebus sic stantibus.
Development potential in the site for other uses must be
ignore.

STEP 4 Building Value + Land Value = Market Value

FACTOR CAUSING DEPRECIATION

1. Age/lifespan of the building:

 The older the building, the higher the depreciation rate;

2. Normal wear and tear:

 Depreciation caused by normal/daily use of a building according to its
purpose/function;

3. Maintenance:
 rate of depreciation depends on degree of maintenance or rather, non-
maintenance

4. Vandalism:
 depreciation caused by vandalism activities such as in public buildings
like schools, libraries.

5. Weather/environment:
 A structure located near the seaside may experience a faster rate of
depreciation

6. Insects and rodents:

 Existence of termites may accelerate the rate of depreciation

7. Construction defects/ design flaws/poor workmanship:

 A building with construction defects may further accelerate the rate of
depreciation
TYPES OF DEPRECIATION AND METHOD OF ESTIMATING DEPRECIATION

Types of Depreciation
 Physical Depreciation
 Functional Depreciation
 Economic Depreciation

Methods of Estimating Depreciation

i. Straight-Line Method/Age-Life Method

ii. Engineering Breakdown Method
iii. Cost to Cure Method
iv. Market Analysis Method/Abstraction Method

STRAIGHT LINE METHOD

 Depreciation is determined based on the age of the subject building.

 The age of a building can be seen from two (2) aspects:
i. physical age
ii. economic age.

Physical age
 the age of the building from the date it was built until the date it
was demolished because it is not habitable anymore.

The economic age

 the age of the building from the date it was occupied until the
date when its use is not optimum anymore.

Formula:
Arrive at a percentage of depreciation in relation to the age of the building.

AGE X 100%
ECONOMIC AGE
ENGINEERING BREAKDOWN METHOD

Under this method, depreciation is broken down into three (3) categories:
 Physical Depreciation
 Functional Depreciation
 Economic Depreciation Engineering

Economic Depreciation
 economic value of the building whereby the optimum value of
the building could not be achieved due to factors which are
beyond the owner’s control.
 Depreciation is incurable.

Functional Depreciation
 depreciation of the function of the building due to certain factors
such as age.
 sub-divided into two (2) types:
 Curable Functional Depreciation;
 Incurable Functional Depreciation

Physical Depreciation
 depreciation of the fabric of the building
 visible and obvious.
 usually superficial in nature
 can be further sub-divided into:
 Curable Physical Depreciation
 Incurable Physical Depreciation
COST TO CURE METHOD

The determination of depreciation based on this method requires a cost estimate to

repair wear and tear of a certain component of the building.

The steps required are:

The building is divided into small

components

Identify the components that has

depreciated

Estimate the cost to repair the

component to new condition

Estimate the rate of depreciation for

every component

Example:

A building was built 10 years ago and you are required to determine the overall
depreciation. Upon inspection, the following information was found out:

Depreciation = (Cost-to-Cure/Cost of Construction New) x 100%

= (RM48,500/RM330,000) x 100%
= 14.69%
+/- 15%
MARKET ANALYSIS

 This method requires evidences of transaction of similar properties and

knowledge of land use values in the locality.
 This will give the market (capital) value of the property being valued.
 The determination of depreciation is based on the Cost Method equation:

CAPITAL VALUE

= VALUE OF LAND + (VALUE OF BUILDING – DEPRECIATION)

 Depreciation can be calculated by re-arranging the equation into:

DEPRECIATION
= (VALUE OF LAND + VALUE OF BUILDING) – CAPITAL VALUE
EXAMPLE OF CASES:
Example: Market Analysis Method

A residential property was transacted for a consideration of RM95,000 per

unit. The land area of the subject property is 400 sq. m and the building area
is 150 sq. m. The building was constructed in 1995.

A study of the cost of construction revealed that the cost to construct the
subject building now is RM500 per sq. m and the land value is RM90 per sq.
m. Estimate the depreciation of the subject building.

Depreciation
= (Value of land + Value of Building) – Capital Value
= ((400 sq m @RM90 psm) + (150 sq m @RM500 psm)) – RM95,000
= (RM36,000 + RM75,000) – RM95,000
= RM111,000 – RM95,000
= RM16,000

The rate of depreciation is

= (Depreciation/Cost of Construction New) x 100%
= (RM16,000/RM75,000) x 100%
= 21.33%

EXAMPLE 1: COST METHODS STAR FURNITURE

Cost Method = Market value Land Value + Building Value

 Comparable 1 has been choose as a comparable property to the subject

property
 Transaction 6,000,000
 Land Area 3Hectares
 Value for each hectare 2000000
o Assuming building life cycle for office is 6o years and factory 45 years
(Factory life cycle is lower because of heavy production)

o Depreciation for assumption might be lower than percentage (by using

straight line method), that refer the building is well- Maintained

o Reserve Price = Market Price (However the value can be reduce depend on
building and market condition)
EXAMPLE 2:
EXAMPLE 3:
Adjustment:

Comparable 4 is most suitable due to the lowest adjustment

TUTORIAL 1:

Telstrat Sdn Bhd owns a double storey detached factory in Bukit Kemuning. Formerly, this
area was located under Majlis Bandaraya Shah Alam (MBSA)..
The information provided as follows:-
Land area : 4 hectares
Tenure : Freehold
Category of land use : Building
Express condition : Land to be used for industrial
Restriction in interest : Nil
Encumbrances : Nil
Building accommodation are as follows:-
Sales of industrial vacant land available within the locality are as follows:-
TUTORIAL 2:

Bintang Furniture Sdn Bhd owns a double storey detached warehouse in Bukit Kayu Hitam,
Kedah. This property was constructed in 2006. Formerly, Bukit Kayu Hitam was located
under Majlis Daerah Kubang Pasu, Kedah.

The information provided is as follows:-

Land area : 6 hectares
Tenure : Freehold
Category of land use : Building
Express condition : Land to be used for
industrial only
Restriction in interest : Nil
Encumbrances : Nil

Building accommodation is as follows:-

As your client Bintang Furniture Sdn Bhd also would like to sell this property through
the auction. Please advise your client.
Sales of industrial vacant land available within the locality are as follows:-

Please find out the differences between 4 types of depreciation and method in
estimating depreciation
ANALYSIS OF BUILDING VALUES

Properties potential applicable..... to cost method:

 specialized industrial
 public libraries
 town halls
 sewage disposal works
 schools