Chapter 12 ESTIMATING DEPRECIATION

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Chapter 12ESTIMATING DEPRECIATION
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ACCRUED DEPRECIATION

• REMEMBER
• Mkt Value Cost new - Accrued Depr. Land
  Value
• AD Cost New Land Value - Mkt Value
• So, AD measures loss/gain in value associated
  with difference in utility between subject and a
  new reproduction
• Accrued Depreciation bridges the gap between cost
  new market value

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ACCRUED DEPRECIATION

• Accrued Depreciation has NOTHING to do with
  accounting depreciation
• Acctg depreciation is the difference between
  HISTORICAL cost and book?? Value
• Based on a set of defined rules
• Valuation AD relates CURRENT cost to Market
  Value
• Based on market factors
• Property can increase in value and still have
  depreciation

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Common Misconceptions

• Cost Approach provides anEquilibrium Value not
  a Market Value
• Cost Approach is Always Useful
• It provides a long-run anchor of reasonableness
  on value estimates

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Common Misconceptions

• Cost Approach is Never Useful
• Cost Value only by accident
• If AD Cost - Value, you need to estimate value
  to estimate AD, therefore it is redundant
• It is not used by market participants
• Cost Approach is valid only if improved to HBU as
  vacant
• In estimating AD, recognize that the improvements
  take a hit in value if they do not reflect the
  HBU of the land as vacant

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Depreciation Categories

• Physical Deterioration
• depends on maintenance over life of property
• Functional Obsolescence
• reflects factors such as
• Overcapacity
• Inadequacy
• Dated Technology
• Changing Tastes
• Changes with Time

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Depreciation Categories

• External Obsolescence
• Loss (increase) in Value due forces outside the
  property
• locational (Odana Road)
• economic (Supply Demand out of Equilibrium)
• Locational Obsolescence is already reflected in
  land value, so only apply an appropriate amount
  to the improvement
• Land doesnt depreciate, but

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Accrued Depreciation

• Relationship between age and depreciation
• Generally as age increases, depreciation
  increases
• Not a linear relationship
• Age most closely related to physical depreciation
  , then functional , then external

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MEASURING ACCRUED DEPRECIATION

• Physical Deterioration
• Lump sum method
• Functional and External Obsolescence
• Breakdown method

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Age/Life Method

• Lump Sum (Age/Life) Method
• Two subgroups Effective - Modified Effective
• estimate economic life (50-55 years for house)
• estimate effective age (how old the house
  function really is)
• No generally accepted method of estimating
  effective age
• Accrued Deprec ( Effective Age / Economic Life
  ) X Cost New

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Modified Age/Life Method

• Modified Age/Life
• Curable vs. Non-curable
• if cost of cure lt gain in value to property
  then cure
• Economic issue, not a physical issue
• adjust the effective age for curable

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Modified Age/Life

• Steps
• Subtract costs to cure physical and functional
  depreciation (i.e. curable part) from
  reproduction cost new
• Apply adjusted age/life ratio to adjusted cost
  above (i.e. incurable part)
• Subtotal depreciation
• Add in land value (HBU)
• (See Example)

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Age/Life Method

• Weakness
• Lumps all forms of depreciation into one category
• Research Results
• Rapid Yrs 1-10, slowing Yrs 10-20, then rapid
• Effective Age is better than Actual Age
• Typical range 0.7 to 1.25 /year of age
• Market Extraction of Rates (Ex)
• If Market is out of Equilibrium, poor results

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Extraction Method

• Calculate depreciation from house sales
• need sales price, land value, reproduction cost
• Need large database for best results (Example)
• See Table 12-3
• Rule of Thumb .7 to 1.25 per year
• Yr. 1-10 higher rate
• Yr. 10-20 level
• Yr. 20 increasing

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Market Condition Factor

• Disequilibrium supply and demand
• Market conditions factor (MCF)
• MCF sales price/(reprod. cost - deprec)
• If MCFgt1, sellers market, increase price
• If MCFlt1, buyer market, lower price

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Market Condition Factor (cont)

• To calculate economic obsolescence
• econ ob. (1 - MCF)(cost new - deprec)
• Value MCF(cost new-deprec) Land
• See Table 12-4

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BREAKDOWN METHOD

• Similar to unit-in-place method of estimating
  replacement cost
• identify each source of depreciation
• estimate each effect on value
• total accrued depreciation
• Infrequently used method

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BREAKDOWN METHOD

• Infrequently used method
• very involved - clients do not want to incur
  expense
• limited to larger projects
• unbundling depreciation components can ignore
  covariance between components
• Ex. Effect of functional obsolescence on a
  structure near the end of its physical life
• Steps in Figure 12-2

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Physical Depreciation

• Physical Depreciation
• Curable (Deferred Maintenance)
• Cost to Cure
• Incurable Physical
• Short-Lived Items
• (Age/Life on each Short Lived Item)
• Long-Lived Items
• (Age/Life applied to (Total RCN - RCN of
  Short-Lived)

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Functional Obsolescence

• Curable
• Deficiency (missing insulation)
• Defect (item must be replaced)
• Superadequacy (excess capacity or size)
• (No adjustment if using Replacement Cost)
• Incurable
• Estimate impact on value (paired sales or income
  loss)
• LOGIC AND CONSISTENCY ARE KEY

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External Obsolescence

• Locational
• Economic
• Matched Pairs
• Capitalized Rent Loss(Compared to What?)