Remaining Economic Life

[fishbig010]

Well, I hope they are paying you about $2,000 for this. Looking at your world, from my world, this would be very complex or at least a time waster. AMC people tend to be idiots pretending to know what they are doing.

Your main question is about REL which is a problem in many markets, not mine.

I admire some of your narrative, it appears you had a good mentor.

The way to support a REL is to do a cost approach on your comps and that will take at least a full day if you do it correctly. You can then support your REL. If you can derive a land value for all of your comparable sales you can estimate the depreciated cost of the improvements.

Let us say that your opinion of value is $1,000,000 and you have determined a land value of $700,000. That means the contributory value of the subject improvements are $300,000. Doing a cost approach, not on the 1004, but in narrative format, will show the total depreciation of the current improvements of your comps.

You support that with completing a cost approach on your comparables showing their land values, their cost NEW and the overall depreciation of the improvements of those properties. That give you a total estimated depreciation of the subject and thus your REL.

The Appraisal Institute has a very good Cost Approach class and you can talk to the instructor about this. The AI does not let idiots teach their classes unlike most other "education" providers.

Awesome, thank you so much! I will definitely look into that class because cost approach seems like a very underrated tool that hasn't been taught properly. I've learned more about in a post than the two "classes" they make you take for your license lol. Now I get to tell the AMC to wait, and we all know how much they love that!

 

[alebrewer]

That give you a total estimated depreciation of the subject and thus your REL.

Didn't you miss a step there? Just because you can extract depreciation, doesn't necessarily mean that you've extracted the REL, does it? The depreciation has to be relative to some estimate of effective age (or TEL), no? IOW, if you've estimated depreciation at 30%, how does that necessarily translate into an REL without being tied to some estimate of effective age? If my estimate of effective age is 20 years, then I can assume a REL of ~ 47 years. If, however, my estimate of effective age is 40 years, then my REL would be ~ 93 years, no? I mean - one can take the inverse of the depreciation estimate per year, but that doesn't always work out, does it?

 

[glenn walker]

If that bad boy will go 25 then it will go 35 : )

 

[Mark K]

It seems to me that you've thoroughly analyzed the physical condition and estimated the remaining physical life, not the economic life.

To me, the question is, "Is it bulldozer bait or not?" If not, your job now is to estimate how long until it is. You seem to be saying that in 25 years you call in the dozer. How did you arrive at this number, aside from the physical depreciation estimates? In any appraisal you have to assume competent ownership that will do necessary routine and preventative maintenance allowing the physical structure to survive indefinitely. Is there a significant number of tear downs in the area?

IMO, REL is determined more from external factors than physical factors. This means that you need to predict/estimate when the improvements will no longer contribute value to the site due to the increase in site value. If the area is gentrifying, it seems to me that 25 years is too long.

OTOH, if you firmly believe that the REL is 25 years, not 20 , not 30, the borrower always has the option of changing the loan to a 25 year term... problem solved.

 

[George Hatch]

I've posted this many times on this forum over the years so most of the regulars have seen this in the past. The formula that Marshall and Swift uses in conjunction with their Depreciation table is very different from what most users realize.

We were taught to use the equation

Economic Life (from M&S estimated lifespans)
- Effective Age * (this being the factor that appraisers are supposed to estimate)
-------------------
Remaining Economic Life

However, that's not how the M&S depreciation methodology and that chart works. They include consideration of these other elements, and they approach depreciation with the idea that most of the loss occurs during the middle of the lifespan, with comparatively little additional loss at each end of that lifespan. Their depreciation curve looks more like a bell curve than a straight line.

Anyways, the equation they use in conjunction with their depreciation table works like this:

Economic Life (from their estimated lifespans)
- Remainder* (based on the appraisers judgement of his this structure will be valued in this location)
---------------
Effective Age (this being the residual)


So going back to my example of the 940sf house built in 1960 and in average condition in Culver City, this is how the actual M&S equation would look:

..55yrs Economic Life
- 0-5 Yrs REL* (because right now it could be considered a wobbler between the existing use vs land value)
--------------
50+yrs Effective Age


But if this same structure in this same condition was located 5 miles to the s/e in South Central L.A. , and depending on what that immediate neighborhood looked like in terms of composition the equation could otherwise look like this:

..55yrs Economic Life
- 30+ Yrs REL* (because right now the underlying land values in this area are at or less than $200k, not $1.3M)
--------------
25yrs Effective Age

 

[glenn walker]

It seems to me that you've thoroughly analyzed the physical condition and estimated the remaining physical life, not the economic life.

To me, the question is, "Is it bulldozer bait or not?" If not, your job now is to estimate how long until it is. You seem to be saying that in 25 years you call in the dozer. How did you arrive at this number, aside from the physical depreciation estimates? In any appraisal you have to assume competent ownership that will do necessary routine and preventative maintenance allowing the physical structure to survive indefinitely. Is there a significant number of tear downs in the area?

IMO, REL is determined more from external factors than physical factors. This means that you need to predict/estimate when the improvements will no longer contribute value to the site due to the increase in site value. If the area is gentrifying, it seems to me that 25 years is too long.

OTOH, if you firmly believe that the REL is 25 years, not 20 , not 30, the borrower always has the option of changing the loan to a 25 year term... problem solved.

In my opinion nobody can ever narrow down a remaining economic life with any accuracy especially a single family home. I have a few homes that are 90 years old, and typically over the years people update or remodel and nobody tears down a house until it is falling down and even then I may pull another 20 years out of it. I think the confusion is appraisers tend to confuse Physical Life with remaining economic life. On a commercial building, its much easier because it generates an-income or-may have been built for a particular use. Anyway I would not try to Micro-Manage a 25 to 30 year life, by making the poor borrower have to get a non-30 year mortgage, it makes no sense and I am not that good.

 

[alebrewer]

But even then, you're making an assumption about TEL, no? Granted - from a (theoretically) reliable source, but nonetheless, assumptions are made... Those assumptions don't work when the home is already older than the 'theoretical' TEL suggested by the cost guide.

 

[George Hatch]

Their table, their analyses based off the data they've collected, their methodology. If we're going to use their table we should be using the same or similar reasoning that table is intended to convey.

Note that their total rate of loss doesn't exceed 80% of cost new, the idea being that even a beater can be brought back into productive use.

In terms of valuing the property and skipping the mechanics for a moment, if we articulate the long form of "REL" that question looks something like:

"given the structure's current condition and considering the composition and market trends in the immediate area, how long do we think these improvements will continue to contribute to the value of the whole, above and beyond the contributory value of the underlying land value?" ​

In the case of the Culver City property my conclusion was that the answer to that question was 0-5 years, which is exactly what I said in my appraisal report. If located in Inglewood or So Central my answer would be very different.

Now, I wasn't valuing that property for a mortgage. That property was one of several properties I'm valuing in an estate. And I made that comment even though I didn't complete a Cost Approach for that assignment. I did complete a land sale analysis (using real land sales) in order to support my HBU analysis. The question occurred to me (early on) during my research so I simply continued to pull on the dangling thread until I found out what I needed to know.

Needless to say, if that appraisal went to a lender and they became aware of the fact that - depending on what type of borrower they were dealing with - they might be making what amounts to a land loan at a 95% LTV it might have been of effect on their loan decision. Or not. Conversely, if I had been appraising that structure in Inglewood and I expressed the opinion that the REL was 25 years or more that wouldn't have been an unreasonable opinion for me to express, either.

The point being that if you use the same methodology M&S uses with their table then it's easy to square your CA with what's actually happening in the market. You only have problems with the CA when you mix-n-match their table with a different equation than it's intended to be used with.

 

[alebrewer]

The point being that if you use the same methodology M&S uses with their table

And what methodology does M&S use to calculate TEL?

 

[glenn walker]

And what methodology does M&S use to calculate TEL?