Depreciation: Raising Your

Understanding of Losses in Value

Norrine Brydon, Chief Research & Data Officer

Edward Martinez, Training Manager

© Copyright 2013 Marshall & Swift/Boeckh LLC

 Marshall & Swift:
The Building Cost Experts
 Is considered to be the authority of the Cost Approach
 Over 90% of property tax assessment offices in the US and
Canada rely on our data to value real property
 Specialty publications and software solutions servicing
nearly 600,000 customers in the US and Canada

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 Depreciation Complexity
 Determining depreciation is not a simple “sit in the office” type of exercise, it
require complete and careful examination of all the components which affect
the depreciation equation.

 Based on research, Marshall & Swift created guidelines to aid in the valuation
and to standardize results. But other than straight line depreciated formula,
the final value comes down to the expertise and thoroughness of the person
performing the valuation.

 Updated Depreciation Sections of MVS and RCH:

 Add New Items
 Adjusted Typical Life Expectancy
 Add Green Building Components

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 Agenda
 Back to the Basics - Understanding Depreciation
o Overview of Common Definitions Terms and Concepts
 How Depreciation affects Assessed Value
 Overview of Standard Methodologies
 Review of M&S Methodologies
o New Life-Cycle Tables
 Methodology
 Instructions and Example
o Existing Extended-Life Theory
 New Instructions and Example
 Summary and Q/A

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 Session
Objectives

1. Greater Consistency in Appraisals

2. Understanding of New Life Cycle Tables
3. Understanding of Existing Extended Life
Theory

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 Back to Basics:
Understanding Depreciation
Depreciation : Loss in value

3 Categories:
1.Physical Deterioration
2.Functional Obsolescence
3.External Obsolescence

2 Components:
All depreciation has an economic component and:
1.May be curable or
2.Incurable

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 Causes of Depreciation:
Physical Deterioration
 Loss in value related to Wear and Tear (combination of use, effects of
aging process, physical decay, structural defects, and action of the
elements)

 Key considerations to pay attention to:

o Condition of Exterior Walls (evidence of smoke, mildew stains, and general decay)
o Condition of Interior (walls, millwork, doors, wall coverings, evidence of smoke,
mildew stains, and general decay)
o Mechanical Equipment Condition
o Roof Condition
o Floors/Floor Covering

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 Causes of Depreciation:
Functional Obsolesce
Loss in value due to something inside property boundary

1. Improved too much: Over-improvement

2. Improved too little: Under-improvement
“What were they thinking?”

What is the perceived market reaction in either utility

or desirability?

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 Causes of Depreciation:
External Obsolesce
Loss in value due to something OUTSIDE property boundary
1. Location (affect small area, generally incurable)
2. Market (affect large area, may be temporary)
Physical
Key considerations to pay attention to:
Physical Factors: Proximity to undesirable
physical (man made or natural) feature Economic
Economic: (Supply/demand unbalance, overbuilding,
decline in employment, decline in sale prices, rents)
Infrastructure: (lack of availability or quality) Infrastructure

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 Is Loss …Curable or Incurable?
 Curable: Physical deterioration or obsolescence of an asset that is repairable
or replaceable at reasonable cost
 Incurable: When a defect in an asset is present and becomes too costly to
repair

Key Importance: A deficiency is curable if the property would increase in value by an

amount equal to, or greater than the amount spent to solve the problem. The
appraiser's concern must not be simply whether a problem can be physically repaired,
but whether the repair would make economic sense.

For example: If spending $2,000 to repair a roof would add $2,000 or more to the
value of the property, then the deterioration of the roof is said to be curable. If fixing
the roof would only add $500 to value, then the condition of the roof would be said to
be incurable.

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 The “Aging Process”
Depreciation is a function of the aging process

Key Importance: Understand “AGE” and how long should Improvements

are expected to last…“LIFE”

Easy: Actual Age – dependent on the building construction date

Complex: Effective Age – requires judgment of assessor / appraiser - “does it

look its age?”

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 Effective Age
The Effective Age of a residence is its age in years as compared
with other residences performing like functions.

Key Importance: It is the actual age less any years that have been
taken off by face-lifting, structural reconstruction, removal of functional
inadequacies, modernization of equipment, etc.

Requires Judgment: All the Factors

in Current State
 Take all factors in current state into consideration
 …based on the reality of the property at the time
of the inspection.

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Steps to Determine the Effective Age
1. Typical Life Expectancy: Determine the residence's Typical Life,
based on its type, exterior wall type and quality, using the "Typical
Lives" table contained in Section E of the Residential Cost Handbook.
2. Remaining Useful Life:  Estimate the building's remaining useful life,
based on an evaluation its condition, construction quality, actual age
and any renovations or repairs that have been made.
3. Effective Age: Subtract the remaining useful life from the Typical Life
to obtain the Effective Age.

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Questions on Basics of
Depreciation

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 How Depreciation Affects
Appraised Value
Overview of Standardized Process:

1. Physical depreciation is loss in value due to physical deterioration.

2. Functional or technical obsolescence is loss in value due to lack of

utility or desirability of part or all of the property, inherent to the
improvement or equipment. Thus a new structure or piece of
equipment may suffer obsolescence when built.

3. External, locational or economic obsolescence is loss in value due to

causes outside the property and independent of it, and is not directly
included in Marshall & Swift tables.

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 How Depreciation Affects
Appraised Value
How to determine depreciation: When considering the extent of physical deterioration,
pay particular attention to the following points as you complete the field inspection of your
subject property, as some types of deterioration may be very apparent, while others may
require a more thorough examination.

 Floors and Floor Coverings – Cracks, chips, missing tiles, unevenness, sagging, worn finish.
 Interior Construction – Cracks in plaster or drywall, open joints in millwork, sticking doors.
 Handicapped Requirements – ADA compliance, barrier-free design, parking, ramps.
 Environmental – EPA, wetlands and air quality compliance, water, soil, radon, asbestos.
 Weather Extremes – Appropriate insulation levels, heat gain or loss, shading, passive or
active.
 Earthquakes – Appropriate bracing, connections to structural shell or foundation, shear walls.

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 How Depreciation Affects Appraised
Value
Multiple Methods:
 Age/Life: The simplest and, in past years, a widely used accounting-type concept of
depreciation, particularly with individual short-lived components, is the straight-line (age/life)
approach. A life expectancy is estimated and a constant annual percentage (equal wear or
serviceability each year) is taken for depreciation so that at the end of that life the depreciation
equals 100% of the initial cost.

 Mid-life Theory: This takes into account that most buildings depreciate little during the first
few years. When it becomes evident that the buildings are no longer new, even though they are
adequately maintained, the maintenance expenses rise, rentals tend to decrease and the
building depreciates faster.

 Extended Life Concept: Starts with the hypothesis that buildings age in much the same
manner as people and that the older they get, the greater is their total life expectancy. This
concept recognizes that a building is in the prime of life before mid-life and that the road is
downhill after that, but that correction of deficiencies may lower the effective age and lengthen
the remaining life.

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 How Depreciation Affects
Appraised Value
Let’s focus on Extended Life Concept
The MVS and RCH include :
o Life Cycle Chart
o Extended Life Theory
User Feedback:
o Life Cycle Chart - Complicated
o Extended Life Theory –Instructions not clear enough
Marshall & Swift Response:
o Created New Life Cycle Table - Simplified Methodology 4 steps
o Extended Life Theory – Simplified Instructions 4 steps

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New Life Cycle Tables: Methodology
New Tables based on:
Occupancy
o Residential
o Commercial Low Finish Occupancies
o Commercial High Finish Occupancies

Framing Type
o Wood Frame
o Masonry
o Steel Frame
o Pre Engineered Metal
o Protected Steel Frame
o Reinforced concrete

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New Life Cycle Tables: Methodology
Create models based on the typical building characteristics

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New
NewLife
Life Cycle Tables:
Cycle Tables Methodology
– Methodology
Develop Example Models
 Examples of some of the models created
o Different occupancies
o Gross floor area estimated
o Number of stories
o Each model has 6 framing types associated

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New Life Cycle Tables: Methodology
Break down the model by its components

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New Life Cycle Tables: Methodology
Weight impact of component to the overall cost of building

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New Life Cycle Tables: Methodology
Apply effective age to each component

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New Life Cycle Tables: Methodology
Replace “Curable” Components as they become 80% depreciated
• Tile Replaced after 14 years
• Terrazzo is considered incurable
• Carpeting Replaced in it’s 10th year.

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 New Life Cycle Tables: Methodology
Graph Results: The numbers in this table represent its overall contribution
to the building through the years.

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New Life
Cycle Tables

Let’s review a step-by-

step example to
use the New Life Cycle
Table.

Just Easy Steps!

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 New Life Cycle Tables
Step 1: Determine The Typical Building Life

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 New Life Cycle Tables
Step 2: Determine the Effective Age of the Building

Typical building Life from Step 1

– Remaining Useful Life
Effective Age
Example:
Average Wood Frame Site Built Home has a Typical life expectancy of
55 year. The Remaining Life estimated to be 45 years

(Life Expectancy 55 Years) – (Remaining Life 45 Years) =

Effective age of 10 Years

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 New Life Cycle Tables
Step 3: Determine Physical Condition

Note: New Matrix helps keep process consistent

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 New Life Cycle Tables
Step 3 Continued: Determine Physical Condition

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 New Life Cycle Tables
Review :
Step 1: Determine Typical building life is
55 years
Step 2: Determine Remaining life is 45
years (Effective Age = 10 years)
Step 3: Determine quality of condition
(use new table)

Step 4: Calculation
Calculation
Cost of property $250,000
Depreciation 20% x .20
Depreciation Amount 50,000
Depreciated Property Value $200,000

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Questions on New Life Cycle Table

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 How Depreciation Affects
Appraised Value
Let’s focus on Extended Life Concept
The MVS and RCH include:
o Life Cycle Chart
o Extended Life Theory
User Feedback:
o Life Cycle Chart - Complicated
o Extended Life Theory –Instructions not clear enough
Marshall & Swift Response:
o Created New Life Cycle Table - Simplified Methodology 4 steps
o Extended Life Theory – Simplified Instructions 4 steps

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 New Instructions For Existing
Extended Life Theory
Finding the depreciated value of a building
using the extended-life theory can be done
in steps:

1.Determine the typical building life of the building

2.Determine the effective age of the building
3.Determine the appropriate depreciation table – Residential or
Commercial
4.Determine the depreciation percentage

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Extended Life Theory: Instructions
Step 1: Determine The Typical Building Life

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 Extended Life Theory: Instructions
Step 2: Determine the Effective Age of the Building

Typical building Life from Step 1

– Remaining Useful Life
Effective Age

Example:
Average Wood Frame Site Built Home has a Typical life expectancy of
55 year. The Remaining Life was Estimated to be 45 years

(Life Expectancy 55 Years) – (Remaining Life 45 Years) =

Effective age of 10 Years

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Extended Life Theory: Instructions
Step 3: Determine the appropriate depreciation table
(Residential or Commercial)

Note: this will

assist you in
determining
correct table

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 Extended Life Theory: Instructions
Review :
Step 1: Determine Typical building life is
55 years
Step 2: Determine Remaining life is 45
years (Effective Age = 10 years)
Step 3: Determine the appropriate
depreciation table (use existing table)

Step 4: Determine the Depreciation

Percentage
Calculation
Cost of property $250,000
Depreciation 09% x .09
Depreciation Amount 22,500
Depreciated Property Value $227,5000

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Questions on Instructions for
Extended Life Theory

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 Session Summary
 M&S provide tools to aid in valuation and standardize the process.
Your takeaways should be:

 Greater Consistency in Assessments

 Understanding New Life Cycle Tables

 Understanding of Existing Extended Life Theory

Key Component: Individual judgment and knowledge of property.

Note: Section 97 Updated: 4Q2012 and Section E Updated: 1Q2013

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Contact us for further assistance… Always happy to help!

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