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Definition: Cost Approach
The cost approach refers to the method of valuation of a real estate property based on the principle of substitution i,e the cost of the property should not exceed the expense of actually developing an equivalent asset.
Thus, Market value of a property = Cost of land + Cost of constructing the building (Reproduction/ replacement costs)– Depreciation (Physical/Functional)
The cost approach is more applicable to a property when it is new/ near-new in terms of its development. This is because, with time, the accrued depreciation of a property has to be factored in, which depends on the method of depreciation used in accounting.
However, the drawback of this approach is that it assumes that the creation of a substitute for a property is possible in all cases, which is not true.
The other methods of property valuation are –
Income approach- Estimation of value based on the net present value of the income produced by the property. Generally used for commercial establishments.
Comparables approach- Based on the similarity of the value of a property with respect to another comparable property.