Ch 7 Flashcards
There are three different kinds of depreciation:
Physical deterioration
Functional obsolescence
External obsolescence
Physical deterioration is
The wear and tear that begins when a building is completed and placed into service.
Physical deterioration can be further broken down into two categories:
curable and incurable.
Economic life is defined as
the period over which improvements to real estate contribute to property value.
Useful life is defined as
The period of time over which a structure or a component of a property may reasonably be expected to perform the function for which it was designed.
Useful life is used when using the breakdown method of estimating depreciation of short-lived building components.
Physical life is defined as
- An estimate of how old a building or improvement will be when it is worn out.
- The total period a building lasts or is expected to last as opposed to its economic life.
Actual age is defined as
the number of years that have elapsed since construction of an improvement was completed, also called historical or chronological age.
Effective age is defined as
the age of property that is based on the amount of observed deterioration and obsolescence it has sustained, which may be different from its chronological age.
The three primary methods of estimating depreciation are:
Age - life method
Market extraction method (sometimes known as the sales comparison method)
Breakdown method (sometimes called the observed condition method)
Remaining economic life is defined as
The estimated period over which existing improvements are expected to contribute economically to a property; an estimate of the number of years remaining in the economic life of a structure or structural components as of the effective date of the appraisal; used in the economic age-life method of estimating depreciation.
Total Economic Life =
Total Economic Life =
Effective Age
+ Remaining Economic Life
Age-Life-Method:
Depreciation =
Effective age/Total economic life X total cost new
Assume a 20-year-old building that would cost $220,000 to build new today. It is in good condition and you estimate the effective age to be 15 years. Your estimate of total economic life is 60 years, based on the experience of similar neighborhoods. What is the depreciation?
Age-Life-Method:
Breaking down the calculations, 15 / 60 = 25% depreciation. Then we simply multiply the cost new ($220,000) by 0.25 and that indicates depreciation of $55,000.
Note that this is a total lump-sum depreciation figure - it does not break the depreciation down into specific types (e.g., physical, functional, or external).
The cost new of the improvements is $245,200, the land value is $75,000 and the effective age is 17. The total economic life expectancy as indicated by comparable sales is 55 years. What is the indicated value by the cost approach?
17 / 55 = .309 or 30.9% $245,200 x .309 = $ 75,767
Total cost of the improvements $245,200
Less total depreciation - 75,767
Depreciated cost $169,433
Plus land value + 75,000
Indicated value by the cost approach $244,433 ($244,000 rounded)
The cost new of the subject property is $235,000, the land value is $70,000 and the effective age is 25. The total economic life is estimated to be 60 years.
The subject has deferred maintenance items that total $4,500. After these repairs, the effective age will be reduced to 20 years.
What is the Indicated value by cost approach?
$235,000 - $4,500 = $230,500 remaining improvement cost (after deferred maintenance)
20 (new effective age) / 60 (total economic life) = .333 (percent of depreciation)
Total cost new $235,000
Minus deferred maintenance -4,500
Remaining improvement cost $230,500 Minus depreciation ($230,500 x .33) - 76,065
Depreciated cost of Improvements $154,435
Plus land value +$ 70,000
Indicated value by cost approach $224,435
Rounded to $225,000
