What is the correct formula for estimating value using the cost approach?

The cost approach to estimating value is based on the principle of substitution, which states that a buyer will not pay more for a property than it would cost to construct an equivalent structure. The formula for estimating value using the cost approach involves calculating the cost to reproduce (or replace) the property, accounting for any depreciation, and then adding the value of the land.

The correct formula is articulated as follows: the cost to reproduce the improvements is first determined. This figure reflects the current cost of constructing a similar building. Next, any depreciation is subtracted from this cost to account for factors such as wear and tear, functional obsolescence, or external obsolescence that diminish the value of the improvements. Finally, to arrive at the total value of the property, the value of the land—considered independent of the structure—is added.

This approach places emphasis on understanding how much it would cost to recreate the property minus any loss in value due to age or condition, alongside recognizing the intrinsic value of the land itself. The addition of land value reflects that land is often a critical component of overall property value and is not subject to depreciation in the same way as buildings are.

Thus, by using the formula "Cost to reproduce - depreciation + value of land