Accurately Calculate Market Value (m = c - d + r)

[App3000]

Actually it doesn't work every time.

Income is missing for rental properties. In-use value is missing, although we can assume that in-use value is simply not a part of the standard definition of ROI.

According to your equation if I buy a home for $10M and it depreciates by 100% before I sell it for $10M, the return on investment is $10M.

$10M = $10M - $10M + ROI ---> ROI = $10M - $10M + $10M = $10M.

If we divide that amount by the cost in order to express it as a percentage, as is typical, that is a 100% ROI. Wow!!

If you ask me, all you have done is break even, i.e. ROI=$0/0%.

So, what is wrong with the formula? For it to work, you have to eliminate depreciation!!! So, if there is 0% depreciation, you pay $10M and sell for $10M, you have $0 ROI. If you sell for $20M, you have $20M- $10M = $10M ROI, or 100% ROI.

So, do you begin to understand?

Or, put it this way, in your equation, you fail to realize that deprecation is reflected, i.e. included, in MV. Cost and Depreciation are events that occur before the sale. Yet Depreciation is really best defined by the Sale/MV. So then, which comes first the Depreciation or the ROI? Where and how do you split the Sale Price between deprecation and ROI? You can't really. And, in fact you don't need to. The Depreciation is already deducted in the Sale Price, because people simply do not pay for depreciation. So, given that your calculation actually must start with the MV, by deducting Depreciation from the right hand side of the equation, you are forced to add it to the left hand side, and so you cancel out the effect of depreciation on ROI, and thus your error.

Or another way:

Your equation m= c-d+r.
or
r = m-c+d.
but
why would you add d to m? That simply cancels out the impact of depreciation. Or in other words if you buy an investment property, taking good care of it has no impact on the ROI. Hmmm. That just doesn't make any sense.

Also, your equation, ignores the impact of time and event dependency.

Which brings up the subject of maintenance costs.

And of course, as already mentioned, there is the time value of money.

There goes your beautiful formula.

Real estate is far more complex than most people realize.

I'm afraid I have to disagree as you are not applying the equation correctly. The equation is not a replacement for the cost approach of a complete home which is the depreciated cost method.
It is a correction to the equation to calculate the contributory value of a single feature. Features such as an in-ground pool, covered deck, renovated kitchen, etc.
Also, remember that ROI can be a positive or a negative value as well as zero.
Thank you for your response.

 

[Terrel L. Shields]

Features such as an in-ground pool, covered deck, renovated kitchen, etc.

And no one can tell you the contributory value of same except by market data and no one sells these items in situ.

 

[RCA]

I'm afraid I have to disagree as you are not applying the equation correctly. The equation is not a replacement for the cost approach of a complete home which is the depreciated cost method.
It is a correction to the equation to calculate the contributory value of a single feature. Features such as an in-ground pool, covered deck, renovated kitchen, etc.
Also, remember that ROI can be a positive or a negative value as well as zero.
Thank you for your response.

It's the same story. Depreciation does not belong in the equation because it is already reflected in the MV, even if you are talking only about the contribution to MV of some component of the property. Of course this whole approach is very flimsy and generally inaccurate. But there are times when common sense dictates that some property component very likelky impacts MV, even in the absense of decent comps. It's easy to think of some rather ridiculous examples. Someone updates their home with a $20,000 luxury range imported from Italy, before putting the house up for sale. The buyer doesn't desire the range, but knows he can turn around and sell it for like-new used for $15,000 and replace it with a lower cost range that suits him fine. Of course, he will pay extra for it - if he can make money on the sale. And in this case, as generally true, you can throw depreciation out the window. All that matters is sale and cost, the difference divided by cost being the ROI percent.

Your error is including depreciation.

My formula for the contributory value in such a case would be:

CV = <market value of the component on the open market> x <percentage of likely buyers who would be interested in paying for the component at MV>

So, for example, let say you have a La Cornue Chateau 150 Kitchen Range, which is listed used on EBay for $30,000. You do a rough survey which indicates that about 50% of likely buyers would be interested in paying for it installed at MV. Then I would estimate the contributory value at 0.50 x $30,000 or $15,000.

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Depreciation is to be disregarded, because it is not all that related to MV, generally speaking. Of course there are different ways to calculate depreciation, including basing it on MV. But that gets damned circular, because ROI is also based on MV. So, you are just inviting problems by including depreciation.

 

[App3000]

It's the same story. Depreciation does not belong in the equation because it is already reflected in the MV, even if you are talking only about the contribution to MV of some component of the property. Of course this whole approach is very flimsy and generally inaccurate. But there are times when common sense dictates that some property component very likelky impacts MV, even in the absense of decent comps. It's easy to think of some rather ridiculous examples. Someone updates their home with a $20,000 luxury range imported from Italy, before putting the house up for sale. The buyer doesn't desire the range, but knows he can turn around and sell it for like-new used for $15,000 and replace it with a lower cost range that suits him fine. Of course, he will pay extra for it - if he can make money on the sale. And in this case, as generally true, you can throw depreciation out the window. All that matters is sale and cost, the difference divided by cost being the ROI percent.

Your error is including depreciation.

My formula for the contributory value in such a case would be:

CV = <market value of the component on the open market> x <percentage of likely buyers who would be interested in paying for the component at MV>

So, for example, let say you have a La Cornue Chateau 150 Kitchen Range, which is listed used on EBay for $30,000. You do a rough survey which indicates that about 50% of likely buyers would be interested in paying for it installed at MV. Then I would estimate the contributory value at 0.50 x $30,000 or $15,000.

La Cornue Chateau 150 Kitchen Range | eBay

Find many great new & used options and get the best deals for La Cornue Chateau 150 Kitchen Range at the best online prices at eBay! Free shipping for many products!

www.ebay.com

Depreciation is to be disregarded, because it is not all that related to MV, generally speaking. Of course there are different ways to calculate depreciation, including basing it on MV. But that gets damned circular, because ROI is also based on MV. So, you are just inviting problems by including depreciation

Remember that the equation is to determine the market value of a feature. In your scenario, you are already starting with market value. Depreciation is a necessary variable because buyers factor this in when determining the value. For instance, if a feature is halfway through its economic life then buyers are not willing to pay new construction prices for it. It must be discounted for the depreciation and the shortened expectation of future use with an earlier replacement date.

 

[alebrewer]

Depreciation is a necessary variable because buyers factor this in when determining the value. For instance, if a feature is halfway through its economic life then buyers are not willing to pay new construction prices for it. It must be discounted for the depreciation and the shortened expectation of future use with an earlier replacement date.

I disagree, but that's kind of the point of interaction, huh? Buyers typically don't factor in depreciation. Buyers typically determine whether some feature is functioning as it should, or if it's not, and if it is - what is the likelihood that it won't function in the near future. They don't calculate depreciation in order to arrive at a contributory value of the component. That's an appraiser paradigm...

 

[glenn walker]

And no one can tell you the contributory value of same except by market data and no one sells these items in situ.

Appraisers are almost 90% wrong when determining either contributory value or deprecation . In CA Pools new are now typically between $35,000 to $75,000 in average size homes $100K plus in large homes. Once installed most are re-gunited a new pump etc every 10 years and pools in CA at 60 years old are often fully functional . Where the appraiser messes up is he/she does not take into account that most of these things are going to be updated as time goes on and even more so on structures where physical depreciation is way too high because again most homes are updated and remodeled one two three times before they come to an end of life. Even using regression on things like Pools is rarely accurate.

 

[George Hatch]

REL is not a strictly a measure of physical condition.

 

[glenn walker]

REL is not a strictly a measure of physical condition.

Thats true but the OP is mixing it into the equation

 

[George Hatch]

The CA is a market approach. The difference between a contractor's cost breakdown vs an appraiser's CA is the inclusion of the market-based profit/loss factor.

 

[App3000]

I disagree, but that's kind of the point of interaction, huh? Buyers typically don't factor in depreciation. Buyers typically determine whether some feature is functioning as it should, or if it's not, and if it is - what is the likelihood that it won't function in the near future. They don't calculate depreciation in order to arrive at a contributory value of the component. That's an appraiser paradigm...

Also, remember that depreciation can have a zero value and in many cases, this may be true. Just as the ROI can have a zero value. However, depreciation must be accounted for, even if zero, which is why we use the "depreciated cost method" when performing the cost approach.