Cost Approach

The cost approach adds the land's value to the cost of building the improvements new, then subtracts depreciation. It is the third appraisal method next to sales comparison and income. It works best for new buildings and special-use property with few comparable sales.

For a rental, the cost approach is a check on the cap rate. If NOI capitalized at market rates produces a value well above replacement cost, builders have a reason to add supply, which tends to push rents and values back down over time.

When a property's income value falls below what it would cost to build, new construction slows. Comparing the two helps explain why cap rates and building activity move together over the property cycle.