The Cost Approach and Functional Obsolescence

Abstract

The cost approach in appraisal utilizes the concept of functional obsolescence as one of three components of depreciation. The theory of functional obsolescence is developed from notions about how present value and the cost-new vary across different levels of an attribute of a building as well as how the costs to cure functional obsolescence vary with changes in the attribute. The implications for appraisal practice are derived from the theory. A number of formulations of the cost approach are found that look different but are essentially identical. Reproduction cost estimates are discovered to be irrelevant, but replacement cost estimates are not. The theory justifies the use of a traditional replacement cost approach when dealing with functional obsolescence.

The authors are grateful to Roger E. Cannaday, Joseph W. Trefzger. and an anonymous referee for providing many thoughtful comments.