Part 12 Applied Depreciation

Question 1

If the effective age is 15 years and the remaining economic life is 60 years, what is the percent of accrued depreciation?

Answer 1

Did you get 25%?

Unfortunately, that is incorrect. You need to add the age of 15 years to the remaining life of 60 to get a total life of 75 years. Age/Life is based on age divided by life (total life), not remaining life. Once you have the total life, you can calculate the depreciation:

15 years (age) / 75 years (total life) = 0.20 or 20% depreciation.

Question 2

Remember, depreciation is a loss in value to

Answer 2

the improvements alone, as the land itself does not depreciate

Question 3

The first and perhaps most preferred method of estimating depreciation is the

Answer 3

Market Extraction Method

Question 4

To derive the depreciation estimate, select similar improved property sales and
apply the extraction process.

Answer 4

Market Extraction Method

Question 5

Steps to use for the extraction method

Answer 5

1 Select sales of similar properties that have
a comparable amount of depreciation

2 Adjust the sales for certain factors such as property rights conveyed, financing, and conditions of sale

3 Subtract the value of the land at the time of sale

4 Estimate the cost of the improvements for each comparable property at the time of sale.

5 Subtract the depreciated cost of each improvement from the cost of the improvements to arrive at an estimate of total depreciation in dollars.
This is a lump-sum amount that includes all forms of depreciation.

6 Convert the dollar estimates of depreciation into percentages by dividing each estimate of total depreciation by the cost.

7 Divide the percentage of depreciation by the age of the building to convert the percentage to an annual rate.

Question 6

Limitations of using extraction for estimating depreciation

Answer 6

1. Accuracy of the method depends on the availability of comparable improved
   property sales and also on vacant land or site sales.
2. Real property interests conveyed should be the same for the comparable
   sales and the subject property because adjusting such sales would be
   difficult.
3. As noted before, the extraction method does not separate the depreciation
   into categories such as physical, functional, or external.

Question 7

the extraction method does not separate

Answer 7

the depreciation into categories such as physical, functional, or external.

Question 8

Age-Life Method of Depreciation

The following are the four essential formulas for the age-life method

Answer 8

1. This is the simplest relationship, showing that adding the effective age and remaining economic life together will give the total economic life. For example, if you were 25 years old, and had a remaining life of 75 years, your total life would be 100 years.
2. Effective age divided by economic life equals percent depreciation
3. The percent of depreciation accrued multiplied by the cost gives us the dollar amount of depreciation.
4. cost minus depreciation, which gives us the depreciated cost, also known as the contributory value of the improvements

Question 9

We will be using several of these formulas as sequential steps in estimating the contributory value (depreciated cost) of the improvements.

Answer 9

First, economic life is estimated by adding together effective age and remaining economic life, for an indication of total economic life.
Then, the percent (%) of depreciation is calculated by dividing effective age by economic life, which is the use of the basic age/life ratio (formula).
If required, the percent (%) of depreciation can be multiplied by the cost of the improvements to reflect the dollar amount of depreciation.
Finally, if the dollars of depreciation are subtracted from the cost, the value will be the difference.

Question 10

He owns a building that has a current cost of $400,000. Economic life is 80 years and IO is $35,000. The capitalization rate is 9% and remaining economic life is 70 years. What is the percent of depreciation for the building?

Answer 10

80 (total life) - 70 (remaining life) = 10 yrs effective age.

Now you can use formula 2 to get depreciation:

10 years (age) / 80 (life) = 0.125 or 12.5% depreciation

Question 11

Actual age is 10 years

Sale price is $925,000

Site value is $250,000

Current cost is $843,750

What is the annual percent of depreciation?

Answer 11

This is going to be similar to the seven steps covered on page 187 of the Course Handbook. Well, first we have to take the sale price and subtract the site value.

$925,000 - $250,000 = $675,000 depreciated cost of the building

Now let’s subtract that from the current cost :

$843,750 - $675,000 = $168,750, which is the amount of depreciation

Once we have the depreciation amount, we can divide it by the current cost :

$168,750 / $843,750 = 0.2 or 20% accrued depreciation

Since the question is asking for the annual percent of depreciation we need to divide by the actual age.

0.20 / 10 years = 0.02 or 2% annual depreciation rate. This is answer C.

Question 12

Accrued Depreciation formula

Answer 12

Effective age/economic life

Question 13

Remaining economic life is 75 years

Economic life is 90 years

Site value is $150,000

Current cost is $435,000

Answer 13

First, we have to figure out the effective age.

90 years - 75 years = 15 years

Now let’s use formula 2 to obtain accrued depreciation:

15 years / 90 years = 0.1667 or 16.67% depreciation

Once we have the depreciation, we can multiply it by the current cost:

$435,000 X 0.1666 = $72,500 amount of depreciation

We need the building cost before we can add in the site value, so let’s subtract the depreciation from current cost.

$435,000 - $72,500 = $362,500 value of improvements

You might think we’re done, but wait! We need to add in the value of the land too.

$362,500 + $150,000 = $512,500

Question 14

The _____ method is the simplest way to estimate accrued depreciation.

Most commonly used method of depreciation.

Answer 14

Age-life method.

Works best for newer properties

is based on a ratio

it assumes every building depreciates on a straight-line basis over the course of its economic life.

Question 15

Another weakness is that age-life

Answer 15

does not divide depreciation into subcategories

Age-life does not distinguish between short-lived and long-lived items of depreciation

Question 16

Since depreciation for this method is assumed to be straight-line, you can use market data to derive the economic life from comparable sales

Answer 16

Age-life Depreciation

Economic life = 100% \ Annual % depreciation

Question 17

Let me give you an example of how this works. Assume that you had used the methodology discussed above to extract the annual rate of depreciation from several comparable sales of 1.25% per year. You want to know the implied economic life of the improvements. The question becomes: At a level rate of 1.25% per year, how long will it take for all of the value to be depreciated? I can work this one out in my head, and I’m sure you can too. It is 80 years. Don’t see it? Then use the formula as follows:

Answer 17

Economic Life = 100% / Annual % Depreciation
Economic Life = 1 (100 percent) / 0.0125 (% annual rate)
Economic Life = 80 years

Question 18

Introducing the Breakdown Method

Why is it called the breakdown method?

Answer 18

It’s called the breakdown method because the structure is broken down into various components based upon the time they will contribute value, such as in the short-run, the long-run, or never (as in the case of a component that is broken and in need of immediate repair).

Question 19

This is 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 in the breakdown method to estimate physical depreciation on short-lived and long-lived components.

Answer 19

Useful life

Question 20

The estimated period during which improvements will continue to provide utility; an estimate of the number of years remaining in the useful life of the structure or structural components as of the effective date of the appraisal. Used in the breakdown method of estimating depreciation.

Answer 20

Remaining useful life

These terms are used in lieu of economic life and remaining economic life when discussing individual components of a structure

These terms generally apply to components such as roofs, appliances, or floor coverings.

Question 21

Actual age rather than effective age is used in estimating remaining useful life. So,

Answer 21

if a water heater has a life expectancy of 10 years and its actual age is 4 years, the remaining useful life is 6 years

Question 22

When we say curable, we are not talking about whether the item can actually be repaired (cured) or not, but

Answer 22

whether it is economically feasible to cure the item

Simply stated, the value added must be equal to or greater than a cost to cure.

Question 23

involves relatively minor items that are normally taken care of in the course of regular maintenance.

Answer 23

Curable physical deterioration

These items as often referred to as “deferred maintenance.”

Question 24

are items of deterioration that cannot be practically or economically corrected as of the effective date of appraisal.

Answer 24

Incurable physical deterioration

Question 25

components are items that have an expected useful life that is shorter than that of the entire structure. Examples include roof cover, boiler, carpeting, and appliances. Depreciation in short-lived building components is measured by applying an age-life ratio to the cost of each component. The age-life ratio is the actual age of the component divided by the total useful life (not economic life) of the component.

Answer 25

Short-lived

Question 26

For example, the roof on a house is 8 years old and has a useful life of 20 years. The depreciation of this short-lived item is 40% based on the age/life calculation of 8 years / 20 years. This type of calculation is required for each short-lived component.

Answer 26

Why is this incurable? Because if the roof still has 12 years of life remaining, it would not be economically feasible to replace it today. To do so would waste the remaining 12 years of useful life. Hence it is economically incurable on the effective date of the appraisal.

Question 27

In the breakdown method, the appraiser analyzes each component to determine whether it is curable or incurable. Remember, curability means whether or not it is economically possible to cure, not whether it is physically possible to cure.

Answer 27

.

Question 28

are building components expected to have the same useful life as the entire structure. Examples include the structural steel framing of a high-rise office building, or the wood rafters, framing studs, and concrete foundation walls of a single-family residence.

Answer 28

Long-lived Components

Question 29

Depreciation in long-lived building components is measured by

Answer 29

first deducting the cost of the curable physical items and incurable physical short-lived components from the total cost estimate.

Depreciation in the long-lived components is measured by using an age-life ratio comprised of actual age to total useful life, which is applied to the remaining cost (i.e., the cost of the incurable, long-lived physical components).

Question 30

When functional obsolescence is curable from an economic standpoint, it comes from three categories:

Answer 30

Deficiency requiring addition ( the house that needs a half bath on the first floor).
Deficiency (defect) requiring substitution or modernization ( a house that needs updating kitchen appliances).
Superadequacies (too much of a required item, such as excess air conditioning capacity).

Question 31

Functional obsolescence is incurable when the cost of replacing the outmoded or unacceptable component is more than the anticipated increase in value. This type of loss can come from

Answer 31

either a deficiency or a superadequacy.

Question 32

External Obsolescence
When applying the cost approach, the loss in value due to external influences allocated to the improvements can be measured in two primary ways:

Answer 32

You can select comparable sales exposed to the same influence as the subject and then pair them against sales that are not exposed to the detriment. When data is available, this is the preferred method.
Capitalize the income or rent loss to the building that is attributable to the negative influence. This requires a residual technique.
An alternative procedure capitalizes the total loss due to external obsolescence at the overall capitalization rate (RO) or gross rent multiplier (PGIM or EGIM) and uses the land-to-building ratio to identify the loss in building value. This is because the site has already been valued subject to the obsolescence

Question 33

Breakdown Method: Pros and Cons

Answer 33

breakdown method is the most comprehensive and detailed way to measure depreciation

can separate the total depreciation into its component

These can be further broken down into more precise components (e.g., curable and incurable functional obsolescence).

full application of the breakdown method requires too much time and expense to serve as a practical appraisal technique in all situations

Question 34

Age/Life method is the most commonly used

Answer 34

Market Extraction method is perhaps the most preferred method, as it derives depreciation from market sales.

Question 35

If a window has an effective age of 10 years and a remaining economic life of 25 years, what would the percentage of depreciation be (rounded)?

Answer 35

10 / 35 (total economic life) = 0.28 or 30% rounded.

Question 36

Which of the following would be considered a long-lived component?

Answer 36

framing studs

The structural framing typically lasts the length of the economic life of the improvements and is therefore long-lived.

Question 37

Which method of depreciation is the most complex?

Answer 37

The breakdown method is the most complex because it attempts to measure the depreciation of each component.

Question 38

Depreciation in short-lived building components is measured by applying an age-life ratio to the cost of each component. Which of the following procedures is used to calculate the age-life ratio?

Answer 38

the actual age divided by total useful life

The ratio of actual age to total useful life is the correct method to calculate depreciation in short-lived components.

Question 39

the period of time that the components of the improvement may reasonably be expected to perform the functions for which they were designed

Answer 39

The term useful life is applied to components of a building, contrasted with the term economic life, which is applied to the total improvement.

Question 40

A property has a roof that is 8 years old. It costs $12,000 to replace. Roofs in this market typically last 15 years. What is the amount of value left in this item?
$1,988

Answer 40

$5,640
8 / 15 = 0.533 or 53%.
If 53% is depreciated, 47% is remaining.
So 0.47 x $12,000 = $5,640.

Question 41

A warehouse recently sold for $1,950,000. The land value was estimated to be $750,000, and the replacement cost was estimated at $1,500,000. What percent depreciation was present in the improvements?
20%

Answer 41

$1,950,000 - $750,000 = $1,200,000 (value of improvements).

Now, $1,500,000 (cost new) - $1,200,000 = $300,000 (depreciation).

$300,000 depreciation / $1,500,000 cost new = 20% depreciation rate

Question 42

Which of the following could be a good example of superadequacy?

Answer 42

a house with ten tons of air conditioning when only five tons is required

Question 43

What type of wall enclosure for a porch is the most costly?

Answer 43

knee wall with glass

Question 44

Hopkins sold a warehouse for $950,000, in which the land value was estimated
at $250,000. If the cost to replace the existing warehouse building is
$1.5 million, what is the dollar amount of depreciation accrued to the building?

Answer 44

• C. $800,000 (Step 1: $950,000 − $250,000 = $700,000 bldg. value)
  (Step 2: $1,500,000 − $700,000 = answer)

Question 45

A manufactured home has an effective age of 30 years and a remaining economic
life of 20 years. What is the percent of depreciation for the building?

Answer 45

60% (30 / 50 = 60% depreciation)

Question 46

An apartment building has plumbing and electrical systems that are deteriorated
to the point of requiring complete replacement. This depreciation can be identifi ed
as

Answer 46

physical incurable deterioration.

Question 47

When using the economic age-life method of depreciation, what type of
depreciation is actually measured?

Answer 47

all types of depreciation