Depreciation

Depreciation: Raising Your

Understanding of Losses in Value

Norrine Brydon, Chief Research & Data Officer

Edward Martinez, Training Manager

© Copyright 2013 Marshall & Swift/Boeckh LLC

Marshall & Swift:

The Building Cost Experts

 Is considered to be the authority of the Cost Approach

 Over 90% of property tax assessment offices in the US and

Canada rely on our data to value real property

 Specialty publications and software solutions servicing nearly 600,000 customers in the US and Canada


Depreciation Complexity

 Determining depreciation is not a simple “sit in the office” type of exercise, it require complete and careful examination of all the components which affect the depreciation equation.

 Based on research, Marshall & Swift created guidelines to aid in the valuation and to standardize results. But other than straight line depreciated formula, the final value comes down to the expertise and thoroughness of the person performing the valuation.

 Updated Depreciation Sections of MVS and RCH:

 Add New Items

 Adjusted Typical Life Expectancy

 Add Green Building Components


Agenda

 Back to the Basics - Understanding Depreciation o Overview of Common Definitions Terms and Concepts

 How Depreciation affects Assessed Value

 Overview of Standard Methodologies

 Review of M&S Methodologies o New Life-Cycle Tables

 Methodology

 Instructions and Example o Existing Extended-Life Theory

 New Instructions and Example

 Summary and Q/A


Session

Objectives

1. Greater Consistency in Appraisals

2. Understanding of New Life Cycle Tables

3. Understanding of Existing Extended Life

Theory


Back to Basics:

Understanding Depreciation

Depreciation : Loss in value

3 Categories:

1. Physical Deterioration

2. Functional Obsolescence

3. External Obsolescence

2 Components:

All depreciation has an economic component and:

1. May be curable

2. Incurable or


Causes of Depreciation:

Physical Deterioration

 Loss in value related to Wear and Tear (combination of use, effects of aging process, physical decay, structural defects, and action of the elements)

 Key considerations to pay attention to: o Condition of Exterior Walls (evidence of smoke, mildew stains, and general decay) o Condition of Interior (walls, millwork, doors, wall coverings, evidence of smoke, mildew stains, and general decay) o Mechanical Equipment Condition o Roof Condition o Floors/Floor Covering



Functional Obsolesce

Loss in value due to something inside property boundary

1. Improved too much: Over-improvement

2. Improved too little: Under-improvement

“What were they thinking?”

What is the perceived market reaction in either utility or desirability?



External Obsolesce

Loss in value due to something OUTSIDE property boundary

1. Location (affect small area, generally incurable)

2. Market (affect large area, may be temporary)

Physical

Key considerations to pay attention to:

 Physical Factors: Proximity to undesirable physical (man made or natural) feature

 Economic: (Supply/demand unbalance, overbuilding, decline in employment, decline in sale prices, rents)

 Infrastructure: (lack of availability or quality) Infrastructure

Economic


Is Loss …Curable or Incurable?

 Curable : Physical deterioration or obsolescence of an asset that is repairable or replaceable at reasonable cost

 Incurable : When a defect in an asset is present and becomes too costly to repair

Key Importance: A deficiency is curable if the property would increase in value by an amount equal to, or greater than the amount spent to solve the problem. The appraiser's concern must not be simply whether a problem can be physically repaired, but whether the repair would make economic sense.

For example: If spending $2,000 to repair a roof would add $2,000 or more to the value of the property, then the deterioration of the roof is said to be curable. If fixing the roof would only add $500 to value, then the condition of the roof would be said to be incurable.


The “Aging Process”

Depreciation is a function of the aging process

Key Importance: Understand “AGE” and how long should Improvements are expected to last…“LIFE”

 Easy: Actual Age – dependent on the building construction date

 Complex: Effective Age – requires judgment of assessor / appraiser - “does it look its age?”


Effective Age

The Effective Age of a residence is its age in years as compared with other residences performing like functions.

Key Importance: It is the actual age less any years that have been taken off by face-lifting, structural reconstruction, removal of functional inadequacies, modernization of equipment, etc.

Requires Judgment:

 Take all factors in current state into consideration

 …based on the reality of the property at the time of the inspection.

All the Factors in Current State


Steps to Determine the Effective Age

1. Typical Life Expectancy: Determine the residence's Typical Life, based on its type, exterior wall type and quality, using the "Typical

Lives" table contained in Section E of the Residential Cost Handbook.

2. Remaining Useful Life: Estimate the building's remaining useful life, based on an evaluation its condition, construction quality, actual age and any renovations or repairs that have been made.

3. Effective Age: Subtract the remaining useful life from the Typical Life to obtain the Effective Age.


Questions on Basics of

Depreciation


How Depreciation Affects

Appraised Value

Overview of Standardized Process:

1.

Physical depreciation is loss in value due to physical deterioration.

2. Functional or technical obsolescence is loss in value due to lack of utility or desirability of part or all of the property, inherent to the improvement or equipment. Thus a new structure or piece of equipment may suffer obsolescence when built.

3. External, locational or economic obsolescence is loss in value due to causes outside the property and independent of it, and is not directly included in Marshall & Swift tables.



Appraised Value

How to determine depreciation: When considering the extent of physical deterioration,

pay particular attention to the following points as you complete the field inspection of your subject property, as some types of deterioration may be very apparent, while others may require a more thorough examination.

 Floors and Floor Coverings – Cracks, chips, missing tiles, unevenness, sagging, worn finish.

 Interior Construction – Cracks in plaster or drywall, open joints in millwork, sticking doors.

 Handicapped Requirements – ADA compliance, barrier-free design, parking, ramps.

 Environmental – EPA, wetlands and air quality compliance, water, soil, radon, asbestos.

 Weather Extremes

– Appropriate insulation levels, heat gain or loss, shading, passive or active.

 Earthquakes

– Appropriate bracing, connections to structural shell or foundation, shear walls.


How Depreciation Affects Appraised

Value

Multiple Methods:

 Age/Life: The simplest and, in past years, a widely used accounting-type concept of depreciation, particularly with individual short-lived components, is the straight-line (age/life) approach. A life expectancy is estimated and a constant annual percentage (equal wear or serviceability each year) is taken for depreciation so that at the end of that life the depreciation equals 100% of the initial cost.

 Mid-life Theory: This takes into account that most buildings depreciate little during the first few years. When it becomes evident that the buildings are no longer new, even though they are adequately maintained, the maintenance expenses rise, rentals tend to decrease and the building depreciates faster.

 Extended Life Concept: Starts with the hypothesis that buildings age in much the same manner as people and that the older they get, the greater is their total life expectancy. This concept recognizes that a building is in the prime of life before mid-life and that the road is downhill after that, but that correction of deficiencies may lower the effective age and lengthen the remaining life.



Appraised Value

Let’s focus on Extended Life Concept

 The MVS and RCH include : o Life Cycle Chart o Extended Life Theory

 User Feedback: o Life Cycle Chart - Complicated o Extended Life Theory –Instructions not clear enough

 Marshall & Swift Response: o Created New Life Cycle Table - Simplified Methodology 4 steps o Extended Life Theory – Simplified Instructions 4 steps


New

Life Cycle Tables: Methodology

New Tables based on:

 Occupancy o Residential o Commercial Low Finish Occupancies o Commercial High Finish Occupancies

 Framing Type o Wood Frame o Masonry o Steel Frame o Pre Engineered Metal o Protected Steel Frame o Reinforced concrete


New


Create models based on the typical building characteristics


New


Develop Example Models

 Examples of some of the models created o Different occupancies o Gross floor area estimated o Number of stories o Each model has 6 framing types associated


New


Break down the model by its components


New


Weight impact of component to the overall cost of building


New


Apply effective age to each component


New


Replace “Curable” Components as they become 80% depreciated

• Tile Replaced after 14 years

• Terrazzo is considered incurable

• Carpeting Replaced in it’s 10th year.


New


Graph Results: The numbers in this table represent its overall contribution to the building through the years.


New

Life

Cycle Tables


Let’s review a step-bystep example to use the New Life Cycle

Table.

Just Easy Steps!

New

Life Cycle Tables

Step 1: Determine The Typical Building Life


New

Life Cycle Tables

Step 2: Determine the Effective Age of the Building

Typical building Life from Step 1

– Remaining Useful Life

Effective Age

Example:

Average Wood Frame Site Built Home has a Typical life expectancy of

55 year. The Remaining Life estimated to be 45 years

(Life Expectancy 55 Years) – (Remaining Life 45 Years) =

Effective age of 10 Years


New

Life Cycle Tables

Step 3: Determine Physical Condition

Note: New Matrix helps keep process consistent


New

Life Cycle Tables

Step 3 Continued: Determine Physical Condition


New

Life Cycle Tables

Review :

Step 1: Determine Typical building life is

55 years

Step 2: Determine Remaining life is 45 years (Effective Age = 10 years)

Step 3: Determine quality of condition

(use new table )

Step 4: Calculation

Calculation

Cost of property

Depreciation 20%

$250,000 x .20

Depreciation Amount 50,000

Depreciated Property Value $200,000


Questions on

New

Life Cycle Table



Appraised Value

Let’s focus on Extended Life Concept

 The MVS and RCH include: o Life Cycle Chart o Extended Life Theory

 User Feedback: o Life Cycle Chart - Complicated o Extended Life Theory –Instructions not clear enough

 Marshall & Swift Response: o Created New Life Cycle Table - Simplified Methodology 4 steps o Extended Life Theory – Simplified Instructions 4 steps


New

Instructions For Existing

Extended Life Theory

Finding the depreciated value of a building using the extended-life theory can be done in steps:

1. Determine the typical building life of the building

2. Determine the effective age of the building

3. Determine the appropriate depreciation table – Residential or

Commercial

4. Determine the depreciation percentage


Extended Life Theory: Instructions

Step 1: Determine The Typical Building Life



Step 2: Determine the Effective Age of the Building

Typical building Life from Step 1

– Remaining Useful Life

Effective Age

Example:

Average Wood Frame Site Built Home has a Typical life expectancy of

55 year. The Remaining Life was Estimated to be 45 years

(Life Expectancy 55 Years) – (Remaining Life 45 Years) =

Effective age of 10 Years



Step 3: Determine the appropriate depreciation table

(Residential or Commercial)

Note: this will assist you in determining correct table



Review :

Step 1: Determine Typical building life is

55 years

Step 2: Determine Remaining life is 45 years (Effective Age = 10 years)

Step 3: Determine the appropriate depreciation table (use existing table )

Step 4: Determine the Depreciation

Percentage

Calculation

Cost of property

Depreciation 09%

$250,000 x .09

Depreciation Amount 22,500

Depreciated Property Value $227,5000


Questions on Instructions for

Extended Life Theory


Session Summary

 M&S provide tools to aid in valuation and standardize the process.

Your takeaways should be:

 Greater Consistency in Assessments

 Understanding New Life Cycle Tables

 Understanding of Existing Extended Life Theory

Key Component : Individual judgment and knowledge of property.

Note: Section 97 Updated: 4Q2012 and Section E Updated: 1Q2013


Contact us for further assistance… Always happy to help!


Depreciation - Appraisal Institute

Depreciation: Raising Your

Understanding of Losses in Value

Marshall & Swift:

The Building Cost Experts

Depreciation Complexity

Agenda

Session

Objectives

Back to Basics:

Understanding Depreciation

Causes of Depreciation:

Physical Deterioration

Causes of Depreciation:

Functional Obsolesce

Causes of Depreciation:

External Obsolesce

Is Loss …Curable or Incurable?

The “Aging Process”

Effective Age

Steps to Determine the Effective Age

Questions on Basics of

How Depreciation Affects

Appraised Value

How Depreciation Affects

Appraised Value

How Depreciation Affects Appraised

Value

How Depreciation Affects

Appraised Value

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life Cycle Tables: Methodology

Life

Cycle Tables

Life Cycle Tables

Life Cycle Tables

Life Cycle Tables

Life Cycle Tables

Life Cycle Tables

Questions on

Life Cycle Table

How Depreciation Affects

Appraised Value

Instructions For Existing

Extended Life Theory

Extended Life Theory: Instructions

Extended Life Theory: Instructions

Extended Life Theory: Instructions

Extended Life Theory: Instructions

Questions on Instructions for

Extended Life Theory

Session Summary

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