Cost Method

Replacement Cost Method

• Used to value specialised properties that are seldom sold– Manufacturing:

• Chemical works• Oil refineries

– Public administration• Schools and colleges• Town halls, courts and prisons• Hospitals, art galleries

– Infrastructure• Airports• Railway buildings

• Valuations required for• company accounts• business rates• insurance (known as reinstatement valuations)

Replacement Cost Method

• Assumes that the value of existing property = the cost of providing an alternative similar property

• Must allow for depreciation (due to age and obsolescence)• Method calculates replacement cost rather than market value

• Method:• Cost of new building• Less allowance for depreciation• Plus value of land (not included if valuation is for insurance purposes)• Equals value of property

• Several methods of calculating depreciation allowance• Straight line• Reducing balance• Sinking fund

Replacement Cost Method:Valuation for accounts

A purpose-built industrial property with an estimated life of 90 years with 16 years remaining has a GIA of 2,500 m2 and a site area of 0.8 hectares. The current value of this property needs to be estimated for inclusion in the company accounts.

Land 0.8ha @ £200,000[1] per ha

£160,000

Building modern replacement cost including fees[2]

£300 / m2 £750,000

Less depreciation @ 74/90 years = 82%

(£615,000)

£135,000

Estimated depreciated replacement cost

£295,000

[1] Figure obtained from comparable evidence of land sales[2] An overall figure or prices of component parts may be used

Replacement Cost Method:Valuation for insurance

Also known as reinstatement valuations, provides for a similar property as at the date of the valuation or at the commencement of insurance policy cover, should be carried out at least every three years

Building cost[1] (£/sqm) 1,250

Building area[2] (m) 500

625,000

Less obsolescence[3] allowance (% bldg cost) 25% (156,250)

Less depreciation[4] allowance (% bldg cost) 15% (93,750)

Insurance valuation of existing property 375,000

[1] Building costs can be broken down into component parts and based on a Quantity Surveyor’s bill of quantities[2] Building area can also be broken down[3] Obsolescence may affect different parts of building at different rates[4] Depreciation also can vary according to type of structure

Replacement Cost Method:Valuation for rating

• Method produces a capital value which must be ‘de-capitalised’ at an appropriate yield (usually between 3 – 6%) to find a rental value

• Example valuation of an old hospital building…

Current cost of erecting a modern equivalent) £ 250 mLess: Allowance for age and obsolescence of Existing building (as a % age) say 60% - £ 150 m

Add: value of site on which building stands + £ 3.5 mEffective Capital Value (ECV) of existing building £103.5m

Converted to annual (rental) equivalentmultiply by say 6%£6.21 m