Chapter 12
ESTIMATING LOSS IN VALUE:
ACCRUED DEPRECIATION
Basic Real Estate Appraisal: Principles & Procedures – 9th Edition
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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 Value
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DEPRECIATION DEFINED (Con’t.)
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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
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• 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
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• Physical Deterioration
• Functional Obsolescence
• External (Economic) Obsolescence
Detailed on slides that follow
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CURABLE VS. INCURABLE DEPRECIATION
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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 DEPRECIATION
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Physical 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
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12.4 METHODS OF MEASURING
ACCRUED DEPRECIATION
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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
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STRAIGHT-LINE OR AGE-LIFE METHOD
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• 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%
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SALES DATA (OR MARKET) METHOD
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• 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.
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COST-TO-CURE METHOD (Con’t.)
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Physical Deterioration
• Deferred Maintenance - Curable
• Deferred Maintenance - Incurable
• Short-Lived Items
• Long-Lived Items
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COST-TO-CURE METHOD (Con’t.)
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390
Functional Obsolescence
• Curable – An Addition
• Curable – A Replacement or Substitution
• Curable – Super-Adequacy or OverImprovement
• Incurable – A Deficiency
• Incurable – An Over-Improvement
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CAPITALIZED INCOME METHOD
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• 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.)
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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 & CONCEPTS
Accrued 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-Improvement
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