Cost and Depreciation Analysis
Cost and Depreciation Analysis
This domain tests the cost approach: estimating cost new, separating land from improvements, and measuring physical, functional, and external depreciation. Expect questions on reproduction versus replacement cost and on age-life versus breakdown methods.
Core rules
- Reproduction cost replicates the subject with the same materials and design; replacement cost uses modern materials and methods to produce equivalent utility. Replacement cost is generally more defensible for older property.
- Cost new includes direct costs, indirect costs, and entrepreneurial profit or incentive, but not land.
- Physical deterioration can be curable or incurable and is measured by observed condition or age-life.
- Functional obsolescence is a design deficiency or superadequacy; external obsolescence comes from outside the site, such as market or neighborhood decline.
- Age-life method: depreciation = effective age ÷ total economic life × cost new of improvements.
- Breakdown method estimates each depreciation cause separately; it is more detailed and useful when obsolescence is significant.
Worked example
Improvements have a replacement cost new of $400,000, effective age of 12 years, and a total economic life of 50 years. Land value is $100,000. Physical depreciation = 12 ÷ 50 = 24%. Depreciation = 0.24 × $400,000 = $96,000. Depreciated improvements = $400,000 − $96,000 = $304,000. Indicated value = $304,000 + $100,000 = $404,000. If functional obsolescence of $20,000 were also present, subtract it after physical depreciation.
Traps
Applying depreciation to land; using actual age when effective age better reflects condition; double-counting curable items in both physical and functional categories; including land in cost new; and ignoring entrepreneurial profit in new construction.