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

2. 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 2 Page 376 © 2015 OnCourse Learning

3. 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 3 Page 377 © 2015 OnCourse Learning

4. 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 4 Page 378 © 2015 OnCourse Learning

5. 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 5 Page 379 © 2015 OnCourse Learning

6. USE OF DEPRECIATION IN APPRAISALS 6 Page 379 © 2015 OnCourse Learning

7. 12.2 TYPES & CAUSES OF DEPRECIATION Physical Deterioration Functional Obsolescence External (Economic) Obsolescence Detailed on slides that follow 7 Page 380 © 2015 OnCourse Learning

8. 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 8 Page 380 © 2015 OnCourse Learning

9. TYPES OF ACCRUED DEPRECIATION 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 9 Page 381 © 2015 OnCourse Learning

10. 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 Page 385 © 2015 OnCourse Learning

11. 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 Page 385 © 2015 OnCourse Learning

12. SALES DATA (OR MARKET) METHOD Based on the Principle that Value Loss is determined by the Market… 12 Page 387 © 2015 OnCourse Learning

13. 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 Page 390 © 2015 OnCourse Learning

14. COST-TO-CURE METHOD (Con’t.) Physical Deterioration Deferred Maintenance - Curable Deferred Maintenance - Incurable Short-Lived Items Long-Lived Items 14 Page 390 © 2015 OnCourse Learning

15. 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 15 Page 390 © 2015 OnCourse Learning

16. 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 16 Page 397 © 2015 OnCourse Learning

17. 12.4 COST APPROACH SUMMARY 17 Page 399 © 2015 OnCourse Learning

18. COST APPROACH SUMMARY (Con’t.) 18 Page 400 © 2015 OnCourse Learning

19. 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. 19 Page 401 © 2015 OnCourse Learning

20. 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. 20 Page 401 © 2015 OnCourse Learning

21. IMPORTANT TERMS & CONCEPTS Accrued DepreciationEconomic Obsolescence Age-Life MethodEffective Age Book ValueExternal Obsolescence Capitalized Income MethodFunctional Obsolescence Cost BasisLoss of Utility Cost-to-Cure MethodMisplaced Improvement Curable DepreciationOver-Improvement Current-Value AccountingPhysical Deterioration Deferred MaintenanceRental Loss Method Depreciation in AccountingSales Data Method Depreciation in AppraisalStraight-Line Method Economic LifeUnder-Improvement 21 Page 402 © 2015 OnCourse Learning