Professional Documents
Culture Documents
FIN353 Depreciation
FIN353 Depreciation
Depreciation
Cost As If New as of the date of appraisal
Less Depreciation (from all causes)
Equals Contribution of Improvements to the
Site
Three Types
1. Physical Deterioration - Curable and Incurable
2. Functional Obsolescence - Curable and Incurable
3. External Obsolescence - always incurable
Underlying Concepts
Effective age and Economic life rather than Actual
Age and Physical Life are important standards
Underlying Concepts
Physical Age = Chronological Age
Effective Age is the age indicated by the condition
and utility of the structure. If well-maintained,
with good long-lasting appealing design,
effective age often is less than actual age.
depends on market standards, quality of care
and maintenance.
5
Underlying Concepts
Economic Life is the period of time over which
improvements contribute to property value. This
is usually shorter than useful life.
Underlying Concepts
It is not the same as accountants book depreciation the prescribed systematic write-off of the cost of an
asset over time.
Underlying Concepts
Depreciation:
Basic methods of estimating depreciation
Market Extraction
Age-Life Method
Depreciation
Market Extraction, overall depreciation
1. For a comparable sale observation:
First, find the contribution of the main improvements
for example:
Sale Price:
$250,000
- 100,000
$145,000
5,000
10
Depreciation
Market Extraction, overall depreciation
2. Compare the contribution of improvements to cost as if new
$200,000
- 145,000
$ 55,000
11
Depreciation
Market Extraction, overall depreciation
$ Depreciation Cost As Though New = Depreciation %
$ 55,000 $200,000 = 27.5%
27.5% 15 yrs
1.83%
Depreciation
Market Extraction, overall depreciation
Do this for a number of similar properties:
Sale
1
2
3
4
Eff. Age
10
12
8
15
Deprec.%/yr.
2.0%
1.5%
1.7%
2.2%
Life Exp..
50 yrs
67 yrs
59 yrs
45 yrs
13
Depreciation
Age-Life method; overall depreciation
Concept: Effective Age divided by Total Economic Life equals
Depreciation Percentage.
Example: consider this building:
Actual Age: 18 years; Effective Age: 12 years
Remaining Economic Life is 48 years, so ..
Effective Age = 12
14
Depreciation
Modified Age-Life method; overall depreciation
In the modified method, the physical curable items, or
repairs needed, are deducted first.
Then the effective age and remaining economic life are
considered, as though after the repairs completed, as
before.
For example .
15
100,000
$6,100,000
Subtotal:
$6,050,000
50,000
$4,840,000
1,500,000
$6,340,000
16
Depreciation
Breakdown method
Each type of depreciation is handled in sequence
Depreciation
1. Physical Deterioration
Wear and tear, action of the elements, loss in
value from aging, wearing out, being usedup.
Curable - to cost of replacing or fixing the item
less than the value added to the property.
Incurable - makes no economic sense to fix or
replace the item. Can be short or long lived
items, difference is life of the component.
18
Depreciation
Breakdown method; overall depreciation
In the breakdown method, the physical curable items,
or repairs needed, are deducted first.
Then the short-lived components are analyzed and
depreciation deducted.
Then the residual remaining to be analyzed is the long
lived components. The effective age and remaining
economic life are considered, as though after the
repairs completed, as before.
For example .
19
Building:
Other Improvements:
100,000
$6,100,000
50,000
$6,050,000
$1,204,000
$4,834,000
1,500,000
$6,334,000
20
Depreciation
2. Functional Obsolescence
From inadequacy or super-adequacy (too much or
too little) of building materials, design, floor
plan layout, etc.
$xxx,xxx
-$xxx,xxx
$xxx,xxx
-$xxx,xxx
22
$15,000
$12,000
$25,000
23
00
-$
00
$15,000
-$12,000
24
5,000
$25,000
25
$25,000
-$ 5,000
00
-$
00
Depreciation
3. External Obsolescence
Loss in value of improvements (only) due to
factors outside property boundaries. Almost
always incurable because of being beyond the
owners control.
Causes:
Physical Externality - example: near adverse
influence
Economic - example: currently in economic
downturn, building costs above values.
27
External Obsolescence
Estimate loss to property overall; then allocate to the building
part (land part was considered in site value estimate).
For example: a capitalization rent loss method:
Income loss due to bad influence: $10,000 per year for a
property with 20% of its value in the site.
Capitalization Rate from the Income Approach is 10%.
$10,000 / 10% = $100,000 total
Allocation to the Building:
$100,000 x 80% = $80,000 External Obsolescence
28
29