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```									Chapter 16

The Student Handbook to
THE APPRAISAL OF REAL ESTATE

Depreciation Estimates

1
   Depreciation is the difference between the cost of
construction of the improvements on the date of
appraisal and the value of the improvements as of that
date.
   Depreciation in appraising and accounting

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                    2
Table 16.1 Book Depreciation vs. Market Value

With 2% increase in mark et value                 Book Value       Mark et Value
Purchase price of land and buildings                \$1,250,000       \$1,250,000
Estimated land value                                  -\$250,000         -\$250,000
Estimated building value                            \$1,000,000        \$1,000,000
Annual depreciation rate = 1/39 =       2.56%           -\$25,641
Annual appreciation rate = +2%          2.00%                            \$20,000
Values at the end of year 1            Subtotal      \$974,359         \$1,020,000
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$20,400
Values at the end of year 2            Subtotal      \$948,718         \$1,040,400
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$20,808
Values at the end of year 3            Subtotal      \$923,077         \$1,061,208
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$21,224
Values at the end of year 4            Subtotal      \$897,436         \$1,082,432
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$21,649
Values at the end of year 5            Subtotal      \$871,795         \$1,104,081
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$22,082
Values at the end of year 6            Subtotal      \$846,154         \$1,126,162
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$22,523
Values at the end of year 7            Subtotal      \$820,513         \$1,148,686
Annual depreciation rate = 1/39 =       2.56%         -\$25,641
Annual appreciation rate = +2%          2.00%                            \$22,974
Values at the end of year 8            Subtotal      \$794,872         \$1,171,659
Assume a resale at the end of year 8
Add back in the land value                            \$250,000          \$292,915
\$1,044,872        \$1,464,574
Capital gains income                                  \$419,702

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                          3
   Age and Life Relationships
 Actual Age and Effective Age

   Actual age is a fact.
   Effective age is a numerical estimate.
   Economic Life and Useful Life
   Economic life is the period of time over which
improvements contribute to property value.
   Useful life is the period of time over which a structure
may reasonably be expected to perform the function for
which it was designed.
   Remaining Economic Life and Remaining Useful Life
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                              4
   Methods of Estimating Depreciation
 Market Extraction Method

 Age-Life Method

 Breakdown Method

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                         5
    Market Extraction Method
1. Find comparables with the same losses as the
subject.
2. Make adjustments to the sale prices for
     Property rights included
     Seller financing concessions
     Conditions of sale
       Subtract the value of the land (VL).
       Estimate the reproduction or replacement cost.
       Subtract the calculated value of the building(s) from
the adjusted sale price to show the depreciation.

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                           6
Table 16.2 Depreciation of Newer Improvements
Estimated Using Sales Comparison
Sale 1              Sale 2             Sale 3
Address                          143 Goldenrod Dr.   201 Jasmine Dr.     831 E. 13th St.
Sale price                               \$255,000           \$265,000            \$275,000
Rights conveyed                                 \$0                  \$0                   \$0
Seller concessions                              \$0                  \$0                   \$0
Conditions of sale                              \$0                  \$0                   \$0
Net sale price                           \$255,000           \$265,000            \$275,000
Estimated land value (V L)                -\$50,000           -\$52,000            -\$55,000
Site improvement value                     -\$5,500             -\$6,500            -\$7,500
Depreciated value of buildings           \$199,500           \$206,500            \$212,500
(V )
B
Reproduction cost new                    \$212,000           \$225,000             \$235,000
Less bldg. value                        -\$199,500          -\$206,500            -\$212,500
Total depreciation                        \$12,500            \$18,500              \$22,500
% depreciation                              5.90%               8.22%               9.57%
Actual age                                      3                   5                   6
% depreciation/year                         1.97%               1.64%               1.60%

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                    7
Table 16.3 Depreciation of Older Improvements

Sale 1               Sale 2                Sale 3
Address                                477 Pennsylvania      478 New Jersey        420 Washington
Sale price                                     \$355,000             \$390,000              \$400,000
Rights conveyed                                         \$0                    \$0                    \$0
Seller concessions                                      \$0                    \$0                    \$0
Conditions of sale                                      \$0                    \$0                    \$0
Net sale price                                 \$355,000             \$390,000              \$400,000
Estimated land value (V L)                      -\$65,000            -\$59,000               -\$75,000
Site improvement value                           -\$5,500              -\$6,500               -\$7,500
Depreciated value of buildings (V B)           \$284,500             \$324,500              \$317,500

Reproduction cost new                          \$386,000             \$430,000              \$460,500
Less bldg. value                               -\$284,500           -\$324,500              -\$317,500
Total depreciation                             \$101,500             \$105,500              \$143,000

% depreciation                                    26.30%              24.53%                31.05%
Actual age                                              70                    69                    80
% depreciation/year                                  0.38%                0.36%                 0.39%

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                               8
Table 16.4 Depreciation of an Office Building

Sale 1               Sale 2                Sale 3
Address                                9999 N. Meridian          8809 N.           7765 N. Andrews
Pennsylvania
Sale price                                    \$3,100,000           \$1,250,000            \$4,050,000
Rights conveyed                                 -\$50,000                      \$0                    \$0
Seller concessions                                        \$0                  \$0            -\$35,000
Conditions of sale                                        \$0                  \$0                    \$0
Net sale price                                \$3,050,000           \$1,250,000            \$4,015,000
Estimated land value (V L)                     -\$215,000              -\$75,000            -\$325,000
Site improvement value                          -\$35,000              -\$22,000              -\$55,000
Depreciated value of buildings (V B)          \$2,800,000           \$1,153,000            \$3,635,000

Reproduction cost new                         \$6,600,000           \$3,000,000            \$7,500,000
Less bldg. value                             -\$2,800,000          -\$1,153,000            -\$3,635,000
Total depreciation                            \$3,800,000           \$1,847,000            \$3,865,000

% depreciation                                       57.58%               61.57%                51.53%
Actual age                                                27                  31                    25
% depreciation/year                                   2.13%                1.99%                 2.06%

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                               9
   Age-Life Method
 The effective age divided by the economic life =

depreciation.
 A 10-year-old roof with a 20-year life is 50%

depreciated.
 Applicability and limitations

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                10
   Breakdown Method
 Calculating Depreciation in the Breakdown Method

   Estimate the cost to cure the problem.
   Application of the age-life ratio
   Application of functional obsolescence procedure
   Analysis of market data to obtain physical, functional, or
external losses
   Capitalize income lost
   Applicability and limitations

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                            11
   Types of Depreciation
 Curable physical deterioration – deferred maintenance

 Incurable physical deterioration – short-lived items

 Incurable physical deterioration – long-lived items

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                 12
   Estimating all forms of physical deterioration using age-
life procedure
   Calculating functional obsolescence
   Problem-solving for functional obsolescence
   Using functional obsolescence procedure

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                       13
Table 16.5 The Functional Obsolescence
Procedure
Step   \$     Item                                      Explanation
1     \$      Estimate the cost of the item.            This line represents the cost of the item that is causing the problem. In the case of a missing
item that is causing a loss, this amount would be \$0.

2     -      Less the depreciation already charged     This amount is usually the appraiser’s estimate of the loss due to physical depreciation. This
has to be subtracted from the cost of the item to prevent double counting of the item for both
physical and functional losses. This will be \$0 if there is a missing item.

3     +      Plus the cost to cure or the present      This step is the main adjustment. If the item is curable, the estimate of depreciation will be
value of the loss. (In many cases this    cost of cure; if the item is incurable, the depreciation amount would be the present value of the
includes the cost of retrofitting an      future additional expenses. Adding these amounts will reveal the amount of depreciation that
item.)                                    will be subtracted from the cost new to reduce the value estimate derived via the cost approach.

4     -      Less the cost of the correct item if      This line is a deduction from the amount subtracted from the cost new, which means this line
installed new as of the appraisal date    actually increases the property value. This line is required because this analysis is starting from
the total cost of the item as installed in the building on the date of construction. This is the
cost of the correct item if it were included in the construction when built. It does not include
retrofitting cost.

5     =      Equals the depreciation for functional    This is the amount the appraiser subtracts from reproduction cost new for functional
obsolescence                              obsolescence. This amount lowers the value of the property.

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                                                    14
Table 16.6 Curable Functional Obsolescence
Caused by a Deficiency Requiring an Addition
Step           \$       Item                                Explanation
1             \$0      Estimate the cost of the item.      There is no item on site now, so this is \$0.
2             \$0      Less the depreciation already       Again, since there is no elevator, this is also \$0.
charged
3      \$200,000       Plus the cost to cure or the        This is curable because the owner can spend \$200,000 and return \$210,000 in
present value of the loss.          value. The cost of curing the problem is the cost of installing a new elevator.

4          -\$75,000   Less the cost or the correct item   This has to be subtracted because the market is recognizing only \$210,000
if installed new as of the          difference in the value with and without the item. And the RCN for this building is
appraisal date                      already starting out \$75,000 less than a property that has an elevator. If you don’t
subtract this amount, the value of the property would be lessened twice for the cost of
the item (\$75,000) since the starting-out RCN is already \$75,000 less than a property
with the item in place.

5      \$125,000       Equals the depreciation for         This is correct because a buyer should say “I can buy this one for \$200,000 less
functional obsolescence             (75,000 + 125,000) and then put an elevator in the building.” The \$75,000
represents the lower RCN of the subject improvement without an elevator.

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                                            15
Table 16.7 Incurable Functional Obsolescence
Caused by a Deficiency
Step         \$    Item                                          Explanation
1       \$0       Estimate the cost of the item.                There is no item on site now, so this is \$0.
2       \$0       Less the depreciation already charged         There is no item on site now, so this is \$0.
3    \$100,000    Plus the cost to cure or the present value    The owner los t \$100,000 in land value due to the inablity to sell off
of the los s                                  the two outlots. This is incurable because of the high cost of moving
the building.
4       \$0       Less the cost of the correct item if          There is no correct item here, so the cos t s hould be \$0.
installed new as of the appraisal date
5    \$100,000    Equals the depreciation for functional        This loss is equal to the lost revenue from the sale of the outlots .
obsolescence

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                               16
Table 16.8 Curable Functional Obsolescence Caused by
Deficiencies Requiring Substitution or Modernization
Step           \$      Item                                    Explanation
1         \$20,000     Estimate the cost of the item.          This is the cost of the existing fixtures with magnetic ballasts. Since this is an
estimate of depreciation , not value, this dollar amount will be subtracted from the
cost of construction.

2         -\$10,000    Less the depreciation already           The existing units were not new. This adjustment prevents double counting the
charged                                 physical deterioration of the light fixtures. Note that this amount is subtracted to
reduce the amount of depreciation attributable to the functional obsolescence of
the item by the amount of depreciation attributable to the physical deterioration.

3         \$29,000     Plus the cost to cure or the present    This is the cost to replace the ballasts with the correct item now. This is curable
value of the loss                       because the capital amount of the loss was \$10,000/0.90 = \$111,111, which is a
lot more than the cost of the modernization at \$29,000. This adds to the amount
of depreciation.

4         -\$25,000    Less the cost or the correct item if    This is the cost of installing the more efficient units today during original
installed new as of the appraisal       construction. This lowers the depreciation amount. The difference between the cost
date                                    to cure and the cost of the correct item if installed new (i.e., steps 3 and 4) is the
excess cost to cure.

5         \$14,000     Equals the depreciation for             This amount wil be deducted from the estimate of cost new.
functional obsolescence

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                                                17
Table 16.9 Curable Functional Obsolescence
Step          \$      Item                         Explanation
1        \$5,000     Estimate the cost of the     This is the cost of the existing oversized water heater.
item.
2        -\$3,333    Less the depreciation        The existing units were not new. This adjustment prevents double-
already charged              counting the physical deprecation.
3        \$1,000     Plus the cost to cure or     This is curable because it only cost \$1,000 to put in the correct
the present value of the     unit and the capitalized cost of the extra expense was \$2,000. A
loss                         prudent owner would replace it.
4        -\$1,000    Less the cost or the         This is the cost of ins talling the more efficient units today during
correct item if installed    original construction.
new as of the appraisal
date
5        \$1,667     Equals the depreciation      This amount will be deducted from the estimate of cost new.
for functional
obsolescence

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                   18
Table 16.10 Incurable Functional Obsolescence
Step        \$    Item                                      Explanation
1    \$45,000    Estimate the cost of the item.            There is an item here and this is what it cost.
2         \$0    Less the depreciation already charged     The pool is new.

3         \$0    Plus the cost to cure or the present      This is not curable unless the market actually deducts
value of the loss                         something for having the item. There is no additional cost
because of the pool.
4         \$0    Less the cost of the correct item if      There is no correct item here. This should be \$0.
installed new as of the appraisal date
5    \$45,000    Equals the depreciation for functional    This is clearly the answer and the procedure shows it.
obsolescence                              The cost of the superadequate item is included in the
RCN and by subtracting all of the cost, this should
resemble the thought processes of market participants.

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                19
Table 16.11 Cost Approach

Type of space                                        Area (sq. ft.)        Rate          Amount
Residence                                                2,200        @   \$85.00   =   \$187,000
Basement (base)                                          1,000        @   \$23.00   =    \$23,000
Basement finishing                                       \$800         @   \$22.00   =    \$17,600
Garage                                                   \$750         @   \$22.00   =    \$16,500
Scr. porch                                               \$400         @   \$19.00   =     \$7,600
Estimated RCN all items                                                                \$251,700
Estimated RCN                                                                                                            \$251,700
Short-lived items                          RCN            Age              Life          % DPR.   \$deprec.
Heating and A/C                       \$6,500               \$5         /    \$25     =     20.00%    \$1,300
Plumbing fixtures                    \$11,439               \$5         /    \$30     =     16.67%    \$1,907
Lighting fixtures                     \$9,975               \$5         /    \$30     =     16.67%    \$1,663
Roof covering, etc.                   \$7,500               \$5         /    \$25     =     20.00%    \$1,500
Gutters-downspouts                    \$2,300               \$5         /    \$35     =     14.29%        \$329
Carpet/vinyl                          \$9,500               \$5         /    \$15     =     33.33%    \$3,167
Interior/exterior paint               \$7,500               \$5         /    \$25     =     20.00%    \$1,500
Garage door & opener                  \$3,400               \$5         /    \$15     =     33.33%    \$1,133
T otal                               \$58,114                                                      \$12,498                 -\$12,498

Reproduction Cost New (RCN) of improve ments                                                                  \$251,700
Less the cost of short-lived items                                                                            -\$58,114
Cost new of long-lived items only                                                                             \$193,586
Depreciation extracted from sales comparison (not included herein)                                       \$0
T otal estimated depreciation from all causes                               8.33% x     251,700    =           \$20,967
Short-lived physical depreciation (listed above)                                                              -\$12,498
Estimated depreciation for long-lived items                                                                    -\$8,469     -\$8,469
Subtotal                                                                                                                 \$230,733
Functional losses (floor plan problem)                                                                                     -\$10,000
External losses (none)                                                                                                          \$0
Depreciated value of improvements                                                                                        \$220,733
Site improvements on a net basis                                                                                           \$6,500
Estimated site value at highest and best use as though vacant                                                             \$65,000
Estimated value of the building and site                                                                                 \$292,233
Final value estimate                                                                                                     \$292,233
Rounded to                                                                                                               \$290,000

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                            20
Table 16.12 Residential Cost Approach

Estimated site value                                                         \$45,000
Estimated reproduction cost new of improvements
Dwelling                        2,000  Sq.Ft. @     \$95.00   =   \$190,000
Basement                        1,000  Sq.Ft. @     \$25.00   =    \$25,000
Fireplace, porches, patio, pool                              =    \$35,000
Garage/carport                    750  Sq.Ft. @     \$20.00   =    \$15,000
Total estimated cost new                                         \$265,000
Less                          Physical Functional   External
Depreciation                 \$13,250      \$2,500    \$1,500 =      \$17,250
Depreciated value of improvements                                           \$247,750
"As is" value of the site improvements                       =                \$6,500
Indicated value of cost approach                             =              \$299,250

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                        21
Problems

   Suggested solutions begin on page 365.

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                         22
Problems 7–8

Item                        Age        Life     Cost New   Depreciation
Roof shingles               \$10        \$25      \$6,500       \$2,600
Furnace                     \$10        \$20      \$3,500       \$1,750
Carpets                      \$4         \$8      \$8,500       \$4,250
Vinyl floor covers           \$0         \$8      \$5,500         \$0
Kitchen & bathrooms         \$10        \$30      \$15,000      \$5,000
finishes
Exterior doors              \$10        \$25      \$4,400       \$1,760
Windows                     \$10        \$35      \$2,900        \$828
Total                                           \$46,300     \$16,188

Sale 1     Sale 2     Sale 3      Sale 4
Sale price                \$89,000    \$99,000    \$78,000     \$88,000
Estimated V L             \$17,000    \$19,000    \$16,000     \$17,000
Calculated V B            \$72,000    \$80,000    \$62,000     \$71,000

Estimated reproduction    \$99,500    \$90,000    \$80,000     \$77,000
cost
Less calculated V B       -\$72,000   -\$80,000   -\$62,000    -\$71,000
Calculated depreciation   \$27,500    \$10,000    \$18,000      \$6,000
% depreciation            27.64%     11.11%     22.50%        7.79%
Age of improvement          \$18         \$7        \$15          \$5
% depreciation/year       1.5356%    1.5871%    1.5000%     1.5584%

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                23
Suggested Solution for Problems 7–10

\$7       Estimate the depreciation for physical curable.                    (\$450 for the garage door opener)
\$8       Estimate the depreciation for functional obsolescence.             (\$1,000 the excess cost to cure the floor plan problem)
\$9       Estimate the depreciation for short-lived items.                   (\$16,188 see table above)
\$10      Estimate the depreciation for long-lived items.
The estimated rate of depreciation is 1.5% per year for all forms per the above extraction table, therefore
Total depreciation is .015 x 10 x \$128,700 =                                                                                \$19,305
Less the shower                                                                                                              -\$1,000
Less the short-lived depreciation                                                                                           -\$16,188
Long-lived depreciation is .015 x 10 x \$128,700                                                                               \$2,117

Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 16                                                                                                                        24

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