ESTIMATING LOSS IN VALUE: ACCRUED DEPRECIATION Basic Real Estate Appraisal: Principles & Procedures – 9 th Edition © 2015 OnCourse Learning Chapter 12.

ESTIMATING LOSS IN VALUE:ACCRUED DEPRECIATION

Basic Real Estate Appraisal: Principles & Procedures – 9th Edition

© 2015 OnCourse Learning

Chapter 12

STUDENT LEARNING OUTCOMES

• Distinguish the Concept of Depreciation as it is used in Accounting from that used in Appraisal• Name and give the Causes of Three Types

of Depreciation• Name Four Methods of Estimating Accrued

Depreciation and Describe How they may be applied to a Valuation Problem

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12.1 DEPRECIATION DEFINED

Depreciation Used In Accounting• In Accounting Practice – All Capital Assets

except Land are considered Wasting Assets – Assets that Decline in Value over Time• Book Value – Original Cost or Cost Basis• Depreciation is a Deduction from Cost Basis• Depreciation as allowed by Laws (IRS) or

Declining Cost Basis – Not Related to Value3

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DEPRECIATION DEFINED (Con’t.)

Accrued Depreciation In Appraisals• Estimate of accrued depreciation in appraisal,

is deducted from the estimated cost of the improvements as if new on the date of value, rather than from their historical cost basis• Accrued Depreciation represents the

appraiser’s estimate of the market loss in value as compared to a new building – also referred to as Diminished Utility

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PURPOSE OF DEPRECIATION ESTIMATES• Applied as a Deduction from Cost New on

the Date of Value to Indicate the Depreciated Improvement Value•When Replacement Costs are Used,

estimate does not include any Loss of Utility (i.e. Functional Obsolescence)• Accrued Depreciation Estimates can also

be used in other approaches to value, not just the Cost Approach

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USE OF DEPRECIATION IN APPRAISALS

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12.2 TYPES & CAUSES OF DEPRECIATION

•Physical Deterioration

• Functional Obsolescence

• External (Economic) Obsolescence

Detailed on slides that follow 7

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CURABLE VS. INCURABLE DEPRECIATION

Curable…• if the cost to correct (cost-to-cure) the

condition or defect is less than the amount of value restored. For example, items of Deferred Maintenance

Incurable…• if the cost to correct the condition or

defect is greater than the amount of value restored

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TYPES OF ACCRUED DEPRECIATIONPhysical Deterioration• Reflects Age, Use, Level of Maintenance• Often caused by Deferred Maintenance

Functional Obsolescence• Reflects Loss of Utility caused by faulty building

design and/or floor plan• Over-improvement or Under-improvement

Economic (or External) Obsolescence• Caused by factors outside the boundaries of the

subject property itself 9

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12.4 METHODS OF MEASURING ACCRUED DEPRECIATION

Four Methods• Straight-Line or Age-Life Method• Sales Data (Market) Method• Cost-to-Cure (Observed Condition)• Capitalized Income (or Rent Loss)

Detailed on slides that follow 10

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STRAIGHT-LINE OR AGE-LIFE METHOD• Predicated on all Structures having a Total Useful

Life or Economic Life…• the period over which improvements contribute

to property value• Economic Life is often shorter than the Physical

Life of a Structure; whereby “most buildings are torn down before they fall down”• For a 25 year-old building with an Economic Life

Expectancy of 100 years, accrued depreciation is…

25 ÷ 100 = 0.25, or 25%11

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SALES DATA (OR MARKET) METHOD

• Based on the Principle that Value Loss is determined by the Market…

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COST-TO-CURE METHOD• Measures accrued depreciation by the

cost to cure or repair any observed building defects (i.e. Observed Condition) • After inspection, the appraiser identifies

each building defect, feature, or condition that reduces value • Classified as physical, functional, or

economic (external)• Each must be determined to be either

economically curable or incurable. 13

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COST-TO-CURE METHOD (Con’t.)

Physical Deterioration• Deferred Maintenance - Curable• Deferred Maintenance - Incurable• Short-Lived Items• Long-Lived Items

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COST-TO-CURE METHOD (Con’t.)

Functional Obsolescence• Curable – An Addition• Curable – A Replacement or Substitution• Curable – Super-Adequacy or Over-

Improvement• Incurable – A Deficiency• Incurable – An Over-Improvement

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CAPITALIZED INCOME METHOD• Also referred to the Rental Loss Method• Used to Estimate either the Total Loss in Value

from All Causes, or a Single Cause• Compares the Rent for the Subject as it exists on

the Date of Value to the Rent of a New or Modern building that could take its place

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12.4 COST APPROACH SUMMARY

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COST APPROACH SUMMARY (Con’t.)

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CHAPTER SUMMARY

Accrued depreciation for appraisal purposes is the estimated loss in market value of the improvements, when compared to their replacement or reproduction cost on the date of value. This value loss can be caused by physical deterioration, functional obsolescence, and/or economic obsolescence. Causes can be categorized as economically curable or incurable.

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CHAPTER SUMMARY (Con’t.)

Many types of physical deterioration, such as deferred maintenance, are curable by painting, fixing up, or doing repair work. Accrued depreciation may be estimated by the Straight-line/Age-Life Method, the Sales Data Method, the Cost-to-Cure/Observed Condition Method, or the Capitalized Income/Rent Loss Method.

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IMPORTANT TERMS & CONCEPTSAccrued Depreciation Economic Obsolescence

Age-Life Method Effective Age

Book Value External Obsolescence

Capitalized Income Method Functional Obsolescence

Cost Basis Loss of Utility

Cost-to-Cure Method Misplaced Improvement

Curable Depreciation Over-Improvement

Current-Value Accounting Physical Deterioration

Deferred Maintenance Rental Loss Method

Depreciation in Accounting Sales Data Method

Depreciation in Appraisal Straight-Line Method

Economic Life Under-Improvement21

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