This document discusses depreciation of improvements in the cost approach to real estate valuation. It defines accrued depreciation and effective age, and describes various types of depreciation including physical deterioration, functional obsolescence, and external obsolescence. The document also outlines several methods for calculating accrued depreciation, including the cost to cure method, economic age/life method, and breakdown method. It concludes by summarizing the steps to put all the components together in the cost approach.

1. Unit 12: Cost Approach: Depreciation of
Improvements

2.  Depreciation
• Introduction
o Accrued depreciation is depreciation that has already
occurred.
 This loss in value is equal to the difference between the
replacement cost new of the improvements and their market
value.
• Effective Age and Economic Life
o Effective Age
 The chronological age of the structure is its actual age.
 Effective age describes the age of a structure based on its
condition and usefulness.
o Economic Life
 For income-producing properties, the estimated period
during which the structure will profitably produce income is
its economic life.
 The difference between the structure’s estimated economic
life and its effective age is the remaining economic life.

3.  Depreciation (continued)
• Types of Depreciation
o Introduction
 Physical deterioration of a building and its equipment
includes physical wear and tear, disintegration, decay or rot,
or physical damage of any kind caused by the elements.
 Functional obsolescence refers to deficiencies,
superadequacies, or simply undesirable features found in a
building.
 External obsolescence is attributable to external adverse
conditions that affect a property.
 Curable depreciation refers to a loss in value that is
economically feasible to correct.
 Incurable depreciation refers to items of depreciation that
either are physically impossible to cure or are too expensive
to be worth curing.

4.  Depreciation (continued)
• Types of Depreciation
o Physical Deterioration
 Physical deterioration is the loss in value from all causes of age and
action of the elements.
 It is caused by a number of sources—wear and tear, disintegration,
decay or rot, or physical damage by the elements.
 Property components that exhibit curable physical deterioration can
be repaired or replaced economically.
• This includes deferred maintenance and easily repairable items.
 Deferred maintenance refers to items that are in need of repair due
to lack of upkeep.
 Incurable physical deterioration typically occurs with structural
components that are expected to last for the life of the entire
building.
 Short-lived items are components that are expected to be replaced
during the improvement’s economic life.
 Long-lived items are components of the improvement that are
expected to last as long as the building itself.

5.  Depreciation (continued)
• Types of Depreciation
o Functional Deterioration
 Functional obsolescence is depreciation that is
attributable to an item or feature within the subject
property that is no longer useful or functional.
 Outdated Architectural Design
 Layout Problems. Appraisers must recognize that the
tastes and preferences of society change over time.
 Lack of Modern Facilities. Outmoded features and
equipment al
 Superadequacy. A superadequacy (or over-improvement)
is a feature that is too large or of a higher quality than
needed for a property. so are examples of functional
obsolescence.

6.  Depreciation (continued)
• Types of Depreciation
o External Deterioration
 External obsolescence takes place when influences that are
external to a property adversely affect that property.
 Locational obsolescence is caused by the physical location of
the subject property and its proximity to a negative influence.
 Economic obsolescence occurs when changes in the local
economy affect the subject property’s value.
• Methods of Calculating Accrued Depreciation
o Methods of calculating accrued depreciation include the cost
to cure method, economic age/life method, modified
age/life method, breakdown method (or observed condition
method), market extraction using sales comparison
techniques, and income capitalization method.

7.  Depreciation (continued)
• Methods of Calculating Accrued Depreciation
o Cost to Cure Method
 The cost to cure method is the most basic and
straightforward method to calculate accrued depreciation.
 It is based on observed deferred maintenance and the
application of current building costs at the time of the
appraisal.
 Limitation: This simplistic method only allows for a 100%
depreciation of any item.
o Economic Age/Life Method
 The economic age/life method of calculating accrued
depreciation is conceptually one of the easiest to use and to
understand.
 Also known as the straight-line method or age/life method,
this method is used most frequently by residential appraisers.
 Limitation: It tends to obscure the overall accrued
depreciation estimate since it lumps all items of accrued
depreciation together.

8.  Depreciation (continued)
• Methods of Calculating Accrued Depreciation
o Modified Age/Life Method
 In the modified age/life method, curable physical and
functional items of accrued depreciation are identified.
 Limitation: It does not account for differences in the
remaining economic life of the other building
components.
o Breakdown Method
 In the breakdown or observed condition method, an
appraiser analyzes each type of accrued depreciation
separately, measures the amount of each, and totals the
individual estimates to determine the total accrued
depreciation.
 Then, the total accrued depreciation is deducted from the
reproduction or replacement cost.

9.  Depreciation (continued)
• Methods of Calculating Accrued Depreciation
o Market Extraction using Sales Comparison Techniques
 Sale-Resale Analysis
• In a sale-resale analysis, a property that sells and resells in
a relatively short period of time is analyzed.
 Paired Sales Analysis
• In a paired sales analysis, two similar properties that sell
during the same time period in the same market are
analyzed.
 Extraction
• Extraction enables appraisers to determine the depreciated
value of the improvements of the subject property by
estimating the cost new of recently sold comparables,
minus the sales price of those comparables, and minus the
value of the land in the transaction.

10.  Depreciation (continued)
• Methods of Calculating Accrued Depreciation
o Income Capitalization Method
 The income capitalization method is like the market
extraction method because it is necessary to find similar
income-producing properties both with and without the
same influencing defects.
 Putting It All Together
• Estimate the value of the land component of the
subject property as though vacant and available to
be put to its highest and best use.
• Estimate the reproduction or replacement cost new
of the building improvements on the subject site as
of the effective date of the appraisal.

11.  Putting It All Together (continued)
• Estimate the value of the land component of the
subject property as though vacant and available to
be put to its highest and best use.
• Estimate the reproduction or replacement cost new
of the building improvements on the subject site as
of the effective date of the appraisal.
• Estimate accrued depreciation from all sources
(physical, functional, or external), and deduct from
estimated reproduction or replacement cost.
• Add entrepreneurial incentive, when appropriate.

12.  Putting It All Together (continued)
• Estimate “as-is” value of additional site
improvements, if necessary.
• Add the land value estimate, the depreciated value
of the improvements, the entrepreneurial incentive,
and the value of the site improvements together to
calculate the value estimate by the cost approach.