re614 cost approach
TRANSCRIPT
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Dr. Longhofer Real Estate Appraisal 1
The Cost Approach
Real Estate 614
Real Estate AppraisalDr. Longhofer
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Dr. Longhofer Real Estate Appraisal 2
The Cost Approach
Begin by estimating the cost of any improvementson the landReproduction costis the cost to construct the building
today, replicating it in exact detailReplacement costis the cost required to construct a
building of equal utility, using modern constructiontechniques, materials, and design
Subtract from this the cost of any accruedphysical, functional, or external depreciation
Add in the value of the site as raw land to get theindicated value using the cost approach
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Estimating Construction Costs
Comparative-unit MethodFor relatively standardizedstructures, the size of the building is multiplied by the per-square foot cost of that type of construction
Segregated-cost MethodThe costs of the individualcomponents in the building are used to estimate the overallreplacement cost
Quantity-survey MethodIdentifies the exact materialsrequired to reproduce the structure to estimate the cost
Index MethodAssumes that the replacement cost issimply the original construction cost times a cost index
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Categories of Accrued Depreciation
Physical deterioration is the result of wear andtear, weathering from the elements, vandalism andneglect
Functional obsolescence refers to features, design,and other elements of the building that are not upto modern standards; it also includes features inexcess of what the market can support
(superadequacies) External (economic) obsolescence refers to loss of
value due to influences outside the property
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Estimating Accrued Depreciation
Lump-sum age/life method
Easy to apply
Does not explicitly account for each particulartype of depreciation (esp. econ. obsolescence)
Breakdown methodComplex and time consuming to apply
Explicitly considers each type of depreciation
Helps to avoid double counting
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Age/Life Method
This method estimates depreciation as a lump sum
based on assumed straight-line depreciation
Economic life is estimated using rules of thumb
based on past experience or published sources Effective age is usually used in place of actual
age, but this varies
newCostLifeEconomic
ageEffectiveondepreciatiAccrued
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Modified Age/Life Method
Sometimes the age/life method is modified
by subtracting out curable physical and
functional depreciation before calculatingthe lump sum depreciation of the rest
The idea is that the owner will cure these
problems because it adds more value than itcosts
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Modified Age/Life Method Example
Reproduction cost new $245,000
Physical and functional depreciation, curable 12,500
Adjusted cost $232,500
Total economic life 55 years
Effective age 17 years
% accrued depreciation = 17/55 = 30.9%
Accrued depreciation 71,843
Depreciated value of improvements 160,657
Land value 39,000
Estimated market value $199,657
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Comments on Age/Life Method
Effective age (based on subjective appraiser
judgment) appears to be more accurate than
physical age Depreciation rates of between 0.70 and 1.25
percent per year seems to be a useful benchmark
for properties that are not too old
Depreciation rates can be estimated from
comparable sales (market extraction)
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Market Extraction Example
Sale price of property $1,520,000
Less: Land value 300,000
Less: Contributing value of site improvements 150,000
Depreciated value of improvements $1,070,000
Reproduction cost of improvements $1,500,000
Less: Depreciated value of improvements 1,070,000
Accrued depreciation $430,000
Depreciation = 430,000 / 1,500,000 = 28.67%
Annual depreciation rate (20 years old) 1.43%
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Breakdown Method
In the breakdown method, the physical,
functional and external factors contributing
to the loss in value of the improvements areisolated and estimated separately
This is particularly important for external
obsolescence, which may vary for a propertyover time
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Categories of Depreciation
Physical deterioration
Curable (deferred maintenance)
Incurable Short-lived
Long-lived
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Categories of Depreciation
Functional obsolescence
Curable
Deficiencies Defects
Superadequacies
Incurable
Deficiencies Defects
Superadequacies
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Categories of Depreciation
External obsolescence
Locational
Economic
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Steps in Breakdown Method
1. Identify each component cost and totalcost new; classify as short- or long-lived
2. Estimate cost of deferred maintenance(curable physical deterioration)
3. Estimate cost of curable functional
obsolescence4. Estimate impact of incurable physicaldeterioration on short-lived items
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Steps in Breakdown Method
5. Estimate the impact of long-livedincurable physical deterioration
6. Estimate cost of incurable functionalobsolescence
7. Estimate the impact of external
obsolescence8. Add up total depreciation and estimateproperty value
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Incurable Physical Deterioration of
Short-lived Components For each component, depreciation is
calculated using the age/life method based
on the effective age and useful life of thecomponent
Make sure you subtract off the cost of deferred
maintenance from each component before youcalculate depreciation (avoid double counting)
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Incurable Long-lived Physical
Deterioration Use the age/life method to estimate the
depreciation due to physical deterioration of the
long-lived components Begin with the total reproduction cost of the
improvements
Subtract off the cost of curing deferred maintenance
Subtract off the adjusted cost (after curing deferredmaintenance) of short-lived components
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Curable Functional Obsolescence
Deficiencies are items or features that are
missing and would be required by the
marketThe loss from a deficiency is the difference
between the cost of installing the item today
and what it would have cost to include the item
when the building was constructed
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Curable Functional Obsolescence
Defects are items that are present but do not
meet modern standards
The loss in value due to a defect is the cost ofthe item new less the undepreciatedcost of the
existing item (the part of the cost that has not
yet been depreciated)
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Curable Functional Obsolescence
Superadequacies are features orcomponents that exceed modern standards
Excess cost adjustment methodLoss equalsthe added cost associated with the item less thedepreciation already taken
Rent loss methodLoss equals the capitalized
difference in NOI between what it would taketo support the item compared to market rent,less depreciation already taken
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Incurable Functional Obsolescence
The loss associated with incurable
functional obsolescence is calculated using
the rent loss method
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Incurable External Obsolescence
This, too, is calculated using the rent lossmethod, with some modifications
Use the difference between the buildings rentand market rent for comparable properties
No need to subtract off depreciation alreadytaken because external obsolescence relates to
factors outside the propertyThe loss is generally allocated between land
and building
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Add Up Total Depreciation and
Calculate Market Value
Physical deterioration
+ Incurable short-lived components+ Incurable long-lived components
+ Functional obsolescence
+ External obsolescenceTotal depreciation
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Add Up Total Depreciation and
Calculate Market Value
Reproduction cost new
Total depreciationDepreciated value of improvements
+ Contributing value of site improvements
+ Land valueValue indication from cost approach