Chapter 6 Flashcards
Three kinds of depreciation:
Physical deterioration
Functional obsolescence
External obsolescence
The wear and tear that begins when a building is completed and placed into service.
Physical depreciation
The impairment of functional capacity of improvements according to market tastes and standards.
Functional Obsolescence
This could be evident in an older kitchen or bath that no longer meets market expectations or tastes.
functional obsolescence
This means that the building improvements do not “function” as well as they should.
functional obsolescence
The most common causes of functional obsolescence are
layout problems, outmoded items, inadequacies, superadequacies, and atypical or unusual items.
For example, the heating system is not large enough or the insulation is inadequate. This would be an
inadequacy
These are things that are more than adequate for their intended purpose. Someone paid more for something than was necessary. They will not be able to recoup the additional expense in the marketplace.
Superinadequacies
Functional obsolescence may also be caused by any item that strays far enough from the norm. An item may be, in the abstract, relatively typical and normal on its own. However, when placed in another setting it may become
atypical or unusual enough to cause loss in value
A type of depreciation; a diminution in value caused by negative external influences and generally incurable on the part of the owner, landlord, or tenant. The external influence may be either temporary or permanent. Occurs off the site.
External obsolescence
The difference between the cost of an improvement and its market value on the effective date of the appraisal is
depreciation
obsolescence
effective age
opportunity cost
depreciation
A 10-year-old house will always have
physical deterioration
functional obsolescence
external obsolescence
all of these
physical deterioration
True or False: External obsolescence can be shared between building and land.
True
In most situations, which of these would be considered an example of a superadequacy?
gold-plated faucets
R-90 insulation in walls and ceilings
foundation walls that are 4 feet thick
all of these
all of these
True or False: Functional obsolescence may be present in a brand-new structure.
True
Physical deterioration is best described as
factors outside a property that diminish its value
always incurable
outmoded items
wear and tear
wear and tear
Which of these is NOT a cause of functional obsolescence?
layout problems
inadequacies
superadequacies
deferred maintenance
deferred maintenance
The period over which improvements to real estate contribute to property value.
Economic Life
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
An estimate of how old a building or improvement will be when it is worn out.
Physical Life
The total period a building lasts or is expected to last as opposed to its economic life.
Physical Life
Land ______ lose value simply because it is older, whereas buildings _____ lose value as they age.
won’t; will
Most buildings have an __________ life that is shorter than their ________ life.
economic; physical
The number of years that have elapsed since construction of an improvement was completed; also called historical or chronological age
Actual age
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
Effective Age
The three main methods of estimating depreciation are:
Age-life method
Modified age-life
Breakdown method or observed condition
These two are the primary methods used by real property appraisers. These methods tend to deal with the whole property and are easier to understand. However, the limitations are that they calculate lump-sum depreciation from all causes and do not distinguish between long-lived and short-lived items.
Age-life method and modified age-life
This method is further limited in that it assumes a straight line pattern of depreciation. This may not be realistic as depreciation tends to occur less rapidly in the earlier years of a building’s life and then accelerates towards the end.
Age-life
This method is more detailed and identifies and treats each item of depreciation separately. It is more accurate, but is more time-consuming and requires more research, analysis, and data. Therefore, this method is not generally employed by residential appraisers.
Breakdown method/observed condition
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.q
Remaining Economic Life
f a total economic life is estimated to be 60 years and the current effective age is estimated to be 20 years, then by simple subtraction the remaining economic life is
40 years
Fannie Mae and Freddie Mac no longer require the appraiser to estimate remaining _________ _____, but FHA and VA still do. Other clients might desire to have that information supplied as well.
economic life
In this method, total depreciation is estimated by calculating the ratio of the effective age of a property to its economic life. This gives a percentage of the life that has been used up. It is perhaps less accurate than other methods, because of the judgments involved, but is easy to apply.
Age-life
Age life method formula
(effective age/ total economic life) x total cost = depreciation
(15/60) x $220,000 = $55,000 depreciation
The cost new of the improvements is $245,200, the site value is $60,000, and the effective age is 17. The total economic life expectancy judged by comparable sales is 55 years. What is the indicated value bu the cost approach?
17/55= .309 (or 30.9%)
$245,200 x .309 = $75,767
Total cost of improvements subtracted by the less total of depreciation.
$245,200 - 75,767 = $169,433 (depreciation cost)
Depreciation cost plus site value = indicated value by the cost approach
$169,433 + 60,000 = $229,433
The indicated value should be appropriately rounded. In this case, $230,000
Many appraisers feel this is a preferable method when there are substantial items of deferred maintenance in a property. The cost of the deferred items is subtracted first. This would be more reflective of the way a typical purchaser would consider the property. They would modify the costs by fixing the deferred maintenance items right up front.
Modified Age-Life Method
The cost new of the subject property is $235,000, the site 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.
$235,000 - $4,500 = $230,500 (Remaining Improvement Cost)
20 (effective age) / 60 (total economic life) = .333 (percent of depreciation)
Remaining improvement Cost minus Depreciation = Depreciated Cost Improvements
$230,500 - (230,500 x .33 = 76,065) = $154,435
Depreciated cost of improvements plus site value = value by cost approach then rounded
$154,435 + 70,000 = $224,435
Rounded to $225,000
A building has an effective age of 25 and a total economic life of 80 years. What is its remaining economic life?
31
55
45
not enough information to determine
55
A building has an effective age of 12 and a total economic life of 60 years. It cost $320,000 new and its site value is $95,000. What is the indicated value by cost approach?
$351,000
12 / 60 = 20% depreciation. $320,000 x 0.2 (or 20%) = $64,000.
$320,000 - $64,000 + $95,000 = $351,000
A building has an effective age of 18 and a total economic life of 60 years. It cost $520,000 new and its site value is $125,000. What is the indicated percentage of age-life depreciation?
18 / 60 =
30% depreciation.
4 of 4
The number of years that have elapsed since a building was constructed is its
effective age
actual age
remaining economic life
economic age
actual age
__________ will lose value over time just because of age.
Land
Buildings
Both land and buildings
Land, buildings, and chattel items
buildings
This method is the most detailed and comprehensive way to measure depreciation. It breaks down depreciation into its component parts of physical deterioration, functional obsolescence and external obsolescence and measures each individually.
The breakdown method
Items of physical deterioration or functional obsolescence that are economically feasible to cure. Curing an item of depreciation is economically feasible if the cost to cure is equal to or less than the anticipated increase in the value of the property that would result after curing the depreciation
Curable Depreciation
Physical deterioration can be divided into 3 categories
Deferred maintenance
Short-lived items
Long-lived items
Deferred maintenance is considered to be _______. Conversely, depreciation charged to the short-lived and long-lived items is _________.
curable; incurable
This applies to items that are in need of immediate repair. These are items that should have been taken care of in the normal course of maintenance.
Deferred maintenance
Items of wear and tear on a property that should be fixed now to protect the value or income- producing ability of the property, such as a broken window, a dead tree, a leak in the roof, or a faulty roof that must be completely replaced. These items are almost always curable.
Deferred Maintenance
items are generally (but not always) relatively inexpensive items and will vary according to the type of building. They are things that a conscientious owner would take care of on a regular basis.
Deferred Mainenance
A building component with an expected remaining economic life that is shorter than the remaining economic life of the entire structure.
Short-Lived Items
An item that will probably be replaced one or more times during the life of the improvements, such as painting or flooring.
Short-Lived Items
Short-lived items may still have some life at the time of the appraisal and would NOT need to be replaced immediately. Examples would include:
Roof covering
Water heaters
Carpeting
Furnaces
A roof on a house has an expected life of 20 years. If the economic life of the house is 60 years, the roof might have to be replaced three or more times during the life span of the houses. So the roof covering would be a short-lived item. Now suppose we were appraising that house when it was 15 years old. We might estimate the cost to replace the roof at $4,000. That roof has lost a lot of its life, but there might be 5 years left in it. There is no need to replace it now, because we would just be throwing away money.
However, in the cost approach, we will have to measure its loss of utility and subtract that amount. Fifteen out of 20 years means it has lost .75 or 75% of its value. However, it still retains 25% of its original value.
$4,000 x .75 = $3,000 depreciation.
The roof still has a remaining value of $1,000, but the short-lived depreciation charged to the roof is $3,000.
The deterioration in short-lived items is measured by an age-life ratio applied to the cost of each item. A 15-year-old boiler with an expected life of 25 years will have experienced depreciation of 15 / 25 or 60%.
If the replacement cost of the boiler is $8,000, the amount of short-lived depreciation attributable to the boiler would be:
$8,000 x .60 = $4,800
When applying these age-life ratios we should be utilizing the ______ lives of those components‚ not the ________ life. In other words, how long can that dishwasher be expected to perform the function for which it was designed (i.e., cleaning dishes)?
useful; economic
A building component or site improvement expected to have the same useful life as the entire structure
Long-Lived Items
Long lived items include:
Framing
Foundation
Insulation
Underground pipes
Long-lived items are often referred to as part of the “____ _______” of the building.
bone structure
When totaling up the physical depreciation in a structure utilizing the breakdown method, we first address any _______ __________ items. There may be none identified.
deferred maintenance
Let’s assume a total replacement cost of $200,000. A portion of that is accounted for by the cost of the short-lived items (the roof, furnace, water heater, etc.) and any deferred maintenance. The rest, by default, must be the cost of the long-lived items. It’s process of elimination, like the old saying goes, “If it isn’t one thing‚ it’s got to be the other!”
If we identify the total cost new of the short-lived items to be $50,000 (assume no deferred maintenance), then the cost of the long-lived items has to be $150,000 ($200,000 - $50,000).
Then, remember that the cost of the long-lived items will be depreciated over the remaining economic life of the whole structure. If we estimate the remaining economic life to be 45 years out of a total of 60 years, then the long-lived items have incurred a total depreciation, at this point in their lives, of 15/60 or 25%.
In this example, long-lived depreciation is therefore equal to
0.25 X $150,000, or $37,500.
The house you are appraising has a total cost of $182,844. It is 22 years old and has an estimated remaining economic life of 28 years.
The cost to cure deferred maintenance items is $1,290.
Short lived items of depreciation have been identified; the depreciation attributable to these items is $3,530 and their cost is $12,300.
What is the amount of long-lived depreciation attributable to the building?
The house you are appraising has a total cost of $182,844. It is 22 years old and has an estimated remaining economic life of 28 years.
The cost to cure deferred maintenance items is $1,290 and they are 100% depreciated.
Short lived items of depreciation have been identified; the depreciation is $3,530 and the cost of these items is $12,300.
Total Cost $182,844
Minus Deferred maintenance cost - 1,290
Minus Short-lived items cost - 12,300
Cost of Long-lived items $169,254
The house you are appraising has a total cost of $182,844. It is 22 years old and has an estimated remaining economic life of 28 years.
The cost to cure deferred maintenance items is $1,290.
Short lived items of depreciation have been identified; the depreciation attributable to these items is $3,530 and their cost is $12,300.
What is the total depreciation?
Total life = 22 + 28 = 50 years
Depreciation = 22 / 50 = .44 or 44%
Long-lived depreciation = $169,254 x .44 = $74,472
Long-lived Depreciation $74,472
Deferred maintenance cost to cure + 1,290
Short-lived Depreciation + 3,530
Total Depreciation $79,292
The ability of a property or building to be useful and to perform the function for which it is intended according to current market tastes and standards; the efficiency of a building’s use in terms of architectural style, design and layout, traffic patterns, and the size and type of rooms.
Functional Utility
The impairment of functional capacity of improvements according to market tastes and standards.
functional obsolescence
There are five types of functional obsolescence:
Curable caused by a deficiency requiring an addition
Curable caused by a deficiency requiring substitution or modernization
Curable caused by a superadequacy
Incurable caused by a deficiency
Incurable caused by a superadequacy
A type of depreciation; a diminution in value caused by negative external influences and generally incurable on the part of the owner, landlord, or tenant. The external influence may be either temporary or permanent
External obsolescence
External obsolescence may be estimated by:
Analysis of market data and
Capitalization of income loss
assume a house that would rent for $1,200 per month in a normal market. In this market that has experienced overbuilding, it can only bring $1,150 per month. The appropriate GRM is 120. What is the external obsolescence?
$50 (rent loss) x 120 = $6,000 (external obsolescence)
Assume a house that would rent for $1,200 per month in a normal market. In this market that has experienced overbuilding, it can only bring $1,150 per month. The appropriate GRM is 120. What is the external obsolescence?
$50 (rent loss) x 120 = $6,000 (external obsolescence)
A hot water furnace in a building costs $22,000 to replace. It has an expected life of 30 years, and it is 24 years old. How much shortlived depreciation is attributable to this item?
$17,600
24 / 30 = 80%. $22,000 x 80% = $17,600.
A property is found to suffer $20,000 in external obsolescence because of its proximity to an industrial plant. The subject’s land represents 20% of its value. What is the dollar amount of external obsolescence attributable to the building improvements?
$16,000
$20,000 x 80% = $16,000. The remaining $4,000 in external obsolescence is attributable to the land.
When estimating depreciation, which of these items is likely to be considered a long-lived item?
furnace
roof covering
girders
water heater
girders
The building’s framing members, including girders, would be long-lived items. The other items will likely need to be replaced during the building’s life.
What term is defined as “Items of wear and tear on a property that should be fixed now to protect the value or income- producing ability of the property”?
functional obsolescence
short-lived depreciation
long-lived depreciation
deferred maintenance
deferred maintenance
True or False: Physical deterioration can be divided into three categories: deferred maintenance; short-lived components; and long-lived components.
True
1 of 10
The replacement cost new of the improvements is $295,500, the land value is $75,000 and the effective age is 17 years. The total economic life is estimated to be 60 years. The subject has deferred maintenance items that total $5,500. After these repairs, the effective age will be reduced to 15 years. What is the value of the property using a modified age-life method?
$292,500
Modified Age-Life Method. $295,500 - $5,500 = $290,000.
15 ÷ 60 = .25.
$290,000 X .75 = $217,500. $217,500 + $75,000 = $292,500.
“The period over which improvements to real estate contribute to property value” is the definition of \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ life. economic physical useful actual
economic
“The impairment of functional capacity of improvements according to market tastes and standards” is the definition of
depreciation
physical deterioration
functional obsolescence
external obsolescence
functional obsolescence
Which of these factors is most likely to cause external obsolescence to a residential property?
A roof that shows obvious signs of deterioration but is not yet leaking
A gas station/convenience store located across the street
A kitchen design that does not meet current market tastes and expectations
All of these are examples of external obsolescence
A gas station/convenience store located across the street
External obsolescence can be
marketwide
based on an outdated finish item
the result of a layout deficiency
the result of a construction defect
marketwide
Which would NOT be a deferred maintenance item?
broken window pane
older roof showing some wear
peeling paint on window trim
leaking faucet
older roof showing some wear
“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” is the definition of __________ life.
incurable
physical
useful
actual
useful
The three general types of depreciation are:
Physical, short-lived, and long-lived
Curable, incurable and breakdown
Physical, functional, and external
Functional, curable, and incurable
physical, functional, external
A 12 year old roof with an expected life of 20 years would have experienced depreciation of $\_\_\_\_\_\_ if the cost new of the roof is $8,000. $3,200 $4,200 $4,800 $6,000
$4800
12/20 = .6
.6 x 8000 = 4800
Of the three general types of depreciation, which type occurs off the site?
curable
short-lived
physical
external
external
Which is NOT an example of a long-lived item? water heater framing foundation underground pipes
water heater
Economic feasibility is indicated if the __________ is ______________ the ______________ of the property.
cost, greater than, value
price, equal to or less than, cost
cost to cure, equal to or less than, anticipated increase in value
cost to cure, more than, actual increase in value
cost to cure, equal to or less than, anticipated increase in value
“The ability of a property or building to be useful and perform the function for which it was intended according to current market tastes and standards” is the definition of __________________.
functional obsolescence
functional utility
functional inutility
useful life
functional utility
The amount of depreciation attributed to deferred maintenance is measured by
the cost to build a new structure
the cost to cure the deferred maintenance item
the cost of long-lived items divided by the ratio of effective age to total economic life
chronological age divided by total economic life
the cost to cure the deferred maintenance item
Assume a house would rent for $1,000 per month in a normal neighborhood. In this neighborhood, which is near a busy interstate highway, it can only rent for $950 per month. The appropriate GRM is 135. How much external obsolescence is caused by the highway?
$4,200
$4,750
$5,550
$6,750
$6,750
1000-950 = 50
50 x 135 = 6750
The subject is a 15 year old duplex that would cost $240,000 to build new today. It is in good condition and you estimate the effective age to be 10 years. Your estimate of total economic life is 50 years. Its land value is $60,000. What is its value by the cost approach?
$252,000
Cost Approach Using Age- Life Method.
10 ÷ 50 = .20.
$240,000 X .80 = $192,000. $192,000 + $60,000 = $252,000.
