COST APPROACH EXAM QUESTIONS WITH ANSWERS
Three Economic Principles
Substitution
Contribution
Balance
Substitution
Appraisal principle that states that when several similar or commensurate commodities, goods, or
services are available, the one with the lowest price will attract the greatest demand and widest
distribution
*primary principle of cost and sales approach
Contribution
Relates to the concept that the value of a particular component is measures in terms of its
contribution ot the value of the whole property
Balance
Provides that real property value is created and sustained when contrasting, opposing, or interacting
elements are in a state of equilibrium
Efficiency Ratio
Rentable area/Gross Floor Area
Direct Costs
Expenditures for the labor and materials used in the construction of improvements; also called "hard
costs"
They include all items that are used directly in the construction of the building
Indirect Costs
Expenditures or allowances for items other than labor and materials that are necessary for
construction but are not typically part of the construction contract.
Indirect costs may include administrative costs, professional fees, financing costs and the interest paid
on construction loans, taxes, and the builders all risk insurance during construction, and marketing
sales, and lease up sales
Entrepreneurial Incentive
The amount an entrepreneur expects to receive for his or her contribution to a project.
Entrepreneurial incentive may be distinguished from profit in that it is the expectation of future profit
as opposed to the profit actually earned on a development or improvement.
Entrepreneurial Profit
A market derived figure that represents the amount an entrepreneur receives for his or her
contribution to a project and risk. The difference between the total cost and its market value.
, Entrepreneurial Profit expressed 3 ways
1. As a percentage of direct cost
2. As a percentage of direct and indirect cost
3. As a percentage of total development cost
Market Extraction Method
1. Subtract the vale of the site from the sale price to obtain an estimate of the contributory value of
the principal improvement
2. Subtract the contributory value of the site improvements and the cost of other improvements to
derive the cost of the principal improvement
3. Divide the estimate of total cost by the square foot area of the house to derive the cost per square
foot
4. Apply the cost per square foot to subject
Unit in place
Procedure by which total building cost is estimated by adding together the unit costs for the various
building components as installed (roof, walls, foundation, excavation) standardized costs are used for
structural components and may be applied on the basis of square foot of floor area or linear feet of
wall length of certain height.
Quantity survey method
Based on quantity and quality of all materials used and all categories of required labor are estimated
and unit cost figures are applied to arrive at a total cost estimate for labor and materials
Cost index trending
used to convert a known historical cost into a current cost estimate
Economic Life
Period over which improvements to real estate contribute property value
Remaining economic life
estimated period during which existing improvements are expected to contribute economically to a
property.
Useful life
Period of time over which a structure may reasonably be expected to perform the function for which
it was designed. Tends to be longer than economic life
Physical Life
Applies to the total period a building will last or expected to last as opposed to its economic life
Effective age
Age of a property based on the amount of observed depreciation and obsolescence it has sustained-
estimate
Curable Physical Deterioration
Three Economic Principles
Substitution
Contribution
Balance
Substitution
Appraisal principle that states that when several similar or commensurate commodities, goods, or
services are available, the one with the lowest price will attract the greatest demand and widest
distribution
*primary principle of cost and sales approach
Contribution
Relates to the concept that the value of a particular component is measures in terms of its
contribution ot the value of the whole property
Balance
Provides that real property value is created and sustained when contrasting, opposing, or interacting
elements are in a state of equilibrium
Efficiency Ratio
Rentable area/Gross Floor Area
Direct Costs
Expenditures for the labor and materials used in the construction of improvements; also called "hard
costs"
They include all items that are used directly in the construction of the building
Indirect Costs
Expenditures or allowances for items other than labor and materials that are necessary for
construction but are not typically part of the construction contract.
Indirect costs may include administrative costs, professional fees, financing costs and the interest paid
on construction loans, taxes, and the builders all risk insurance during construction, and marketing
sales, and lease up sales
Entrepreneurial Incentive
The amount an entrepreneur expects to receive for his or her contribution to a project.
Entrepreneurial incentive may be distinguished from profit in that it is the expectation of future profit
as opposed to the profit actually earned on a development or improvement.
Entrepreneurial Profit
A market derived figure that represents the amount an entrepreneur receives for his or her
contribution to a project and risk. The difference between the total cost and its market value.
, Entrepreneurial Profit expressed 3 ways
1. As a percentage of direct cost
2. As a percentage of direct and indirect cost
3. As a percentage of total development cost
Market Extraction Method
1. Subtract the vale of the site from the sale price to obtain an estimate of the contributory value of
the principal improvement
2. Subtract the contributory value of the site improvements and the cost of other improvements to
derive the cost of the principal improvement
3. Divide the estimate of total cost by the square foot area of the house to derive the cost per square
foot
4. Apply the cost per square foot to subject
Unit in place
Procedure by which total building cost is estimated by adding together the unit costs for the various
building components as installed (roof, walls, foundation, excavation) standardized costs are used for
structural components and may be applied on the basis of square foot of floor area or linear feet of
wall length of certain height.
Quantity survey method
Based on quantity and quality of all materials used and all categories of required labor are estimated
and unit cost figures are applied to arrive at a total cost estimate for labor and materials
Cost index trending
used to convert a known historical cost into a current cost estimate
Economic Life
Period over which improvements to real estate contribute property value
Remaining economic life
estimated period during which existing improvements are expected to contribute economically to a
property.
Useful life
Period of time over which a structure may reasonably be expected to perform the function for which
it was designed. Tends to be longer than economic life
Physical Life
Applies to the total period a building will last or expected to last as opposed to its economic life
Effective age
Age of a property based on the amount of observed depreciation and obsolescence it has sustained-
estimate
Curable Physical Deterioration
