4.4.3.1. Foundations of the Cost Approach.Like the sales comparison and income capitalization approaches to value, the cost approach is based on the principle of substitution: a prudent buyer will pay no more for one property than for a similarly desirable property.546 Likewise, when several similar properties are available, the one with the lowest price will attract the greatest demand.547 The cost approach specifically “reflects the notion that one will not pay more for an existing property than it would cost to construct one’s own replacement for the property.”548 But as the Supreme Court recognized, “the value of property may be greater or less than its cost . . . . It is the property and not the cost of it that is protected by the Fifth Amendment.”549 Thus, the cost approach as a means of measuring value “may have relevance—but only, of course, as bearing on what a prospective purchaser would have paid.”550 Its relevance to market value therefore cannot be merely assumed in federal acquisitions; rather, the appraiser must demonstrate that application of the cost approach to a specific property would be relevant to market participants.551 The Ninth Circuit suggested possible ways to make the necessary showing in United States v. 55.22 Acres of Land, such as with evidence that “a prudent investor would reproduce the improvements at the reproduction cost figure [stated],” or that “willing vendees and vendors would deem reproduction cost less depreciation relevant in negotiating a purchase and sale of the property.”552 The court further suggested that limited use of the cost approach as but “one guide” considered by the appraiser in arriving at a fair market value might have been acceptable.553 

Federal courts agree that reliance on the cost approach is improper “when no one would think of reproducing the property,” or when no prudent investor would reproduce it for the figure or amount estimated as replacement or reproduction cost.554 Thus courts reject the cost approach without “unequivocal evidence that the [improvements] involved would be reproduced by private investors at the risk of private capital.”555 

Because the cost approach is designed to inform the valuation of properties with existing physical improvements, it is generally inapplicable to vacant lands, regardless of costs the landowner may have incurred to remove prior improvements. As a district court recently explained in rejecting any use of the cost approach to value a vacant site: 

Efforts and expenditures made by the landowner to bring the property to its present, vacant state, and to maintain it as such, are reflected in the comparison of the parcel to the prices paid on the market for other vacant parcels. Costs to demolish buildings extant on the property and the associated site work, and property maintenance costs such as real estate taxes capitalized, do not inure to the benefit of a prospective buyer over and above any increase in value from the property’s status as vacant land.556 

Moreover, the mere existence of improvements does not automatically justify application of the cost approach; its use is inappropriate where the improvements would be of no value to a prudent buyer due to the nature or condition of the improvements or of the market or other factors,557 or simply because “the original builder guessed wrong.”558 Again, “cost is not synonymous with market value.”559 Thus the Fourth Circuit emphasized the distinction between merely calculating a building’s replacement cost and actually determining a property’s market value: 

[T]he purpose behind determining replacement cost, or original cost, or any of those things[,] is to aid you in determining whether or not the existence of those buildings on the land contributes anything to the fair market value of the whole, and, if it does contribute to it, how much does it contribute? That applies to each and every structure that was on or in the property.560 

To ensure a reliable indication of market value, every element of the cost approach methodology and its underlying assumptions must be carefully scrutinized, supported by market research, and directly linked to the property’s highest and best use.561