Remaining Economic Life

[jtrotta]

Austin;

perhaps some of the most scary aspect's of our business, is to watch someone takdown an old building; some commercial buildings here date back to the late 1700's and I've seen some taken down for the sake of new archet. and new guts for the building. In Europe they retain these items as part of their History, we here generally don't treasure those items, sometimes americana, it's simply amazing.

theory of substitution; is why most UW's want & need similar data for older dwellings; the problem is, most Antique/Vintage properties do not sell in a similar fashion to that of newly constructed dwellings (at least not in my area), so can USPAP & FNMA guidelines (works in progress) be so limited as to not recognize this factor :?: Why shouldn't sections be developed to compensate for those known properties that truely deserve greater latitude (or longitude if ya prefer); beyond 6 months and over the 1 mile - so that it would be a benefit to the appraiser to collect the appropriate data to complete the assignment :?:

Steven S.
my dad was a carpenter back in the early 30's and they built housing during the war years of the 30's & 40's that were on dirt roads, which today are now roadways & parkways. The amount of traffic has increased dramatically; the rumble of trucks pass them dailey, they are now over 60 years of age and resemble the era in which they were built. Modern technology has changed the Buildings and also the building life, if we were to see into the future, what amazing changes would we see in building technology :?: . One thing I have noted over the past several years is that there was a period of time in which most building codes required the use of 2 X 6 framming materials, in the past year it has no longer become a requirement, you can use 2 x 4 materials if you like. Could it be that some recent knowledgeable person realized that most heat loss does not take place thru the walls of the buildings, but rather thru the doors; winda's and ceilings 8O :lol:, and that 2 x 6 or 2 x 8 roof rafters allow for the maximum insulation in that important area. Sorta makes ya wonder if those builders back in the early years (1600 +) really lacked any education in the building business, and how far our technology has really come - donit :wink:

8)

 

[Tom Hildebrandt]

After many words in this thread, we have come to the core of the issue with our profession.

We all know an appraisal is an opinion of value. The definition of an opinion is an idea or belief held with confidence but which can not be substantiated by direct proof or knowledge.

So, almost all of our work products can not be proved, as we have seen in this thread, even statistically derived solutions can not provide defiitive answers. All solutions have some degree of validity and acceptability in our practice. Of course some have more credibility than others, but few of the opinions expressed in this thread discussing effective age can be said to be wrong.

As appraisers we strive for objectivity, we try to have as many facts as possible to support our opinions. If we could prove our opinions, they would be facts, not opinions. But at the end of the day, they remain opinions

Any appraiser who reviews a work product of his peers should remember this key fact. Just as most opinions can not be proven to be right, most opinions can not be proven to be wrong. The facts on which the opinion is based can be shown to be wrong, the method and techniques can be shown to have been incorrectly utilized, but failing those issues, the issue really is whose opinion is more credible, not who is right or wrong.

Many appraisal boards, and reviewers, fail to understand this key concept.

Regards

Tom Hildebrandt GAA

 

[Dick Hemry GAA]

Austin, my scarey man with the chainsaw: I wish I were able to use statistical analysis as comfortably as you appear to. By the way, in your formula for annual rate of depreciation I think you might have made a small error. Shouldn't it be?
1. Sales Price of comparable.
2. Deduction of comps. land value.
3. = contribution of the improvement(s).
4. Now, estimate the replacement cost new.
5. deduct line 3.
6. you now have the depreciated sales price of the improvement(s)
7. deduct any/all outbuildings
8. now you have the depreciated value of the house itself.
9. divide by its effective age.
10. you now have the annual amount of depreciation, st. line.
11. To get he average annual rate of depreciation, divide the annual amount of depreciation by the RCN of the house improvement.
12. Convert the rate to a % (Multiply by 100 and add a percent sign).

I think this is correct.

You know, and I can't find my copy yet, we should read a monologue by a guy named O'Flarety, titled "The Cost Approach - An Appraisers Dilemma". This was part of the Society of Real Estate Appraisers residential valuation course offering in its cost approach section. I'll find it one of these days and post references but I would think that AI (Appraisal Institute) library should have a copy available to anyone who wished one.

To me this is a great thread. I still say most of us don't use the cost approach when improvements are not new or nearly new (special purpose properties excepted). The statistics for proving are great when you know how to handle them. Why I remember in my stats college course we proved a direct correlation between malt beverage (beer) consumption and the number of out houses in Hamilton County, OH. We could bend the number with the best. Hell we could even show a budget surplus for those fools in Washington if necessary. They use stats all the time to their advantage. Statistically, you can prove most anything (not everything) you start out to prove.
It's really snowing here today.
Have a good super bowl party.
Dick Hemry

 

[Austin]

Statistics in the hands of a fool is a dangerous thing. A fool or dishonest person can prove anything with statistics just like an artful fool appraiser can do the same with his artistic methods. My grandson was born December 19, 2002. At his first medical check up I took his average daily weight and height gain and estimated that if that rate continued by his 21st birthday he would weight 17 billion pounds and be 18 feet tall. Not being a fool, I knew not to compare apples to oranges and that the significance of the statistics was that my grandson was growing at a normal rate for his age. There is nothing misleading about statistics unless they are in the hands of a fool of which there is an ample supply. I remember in 1981 when my daughter was 5 years old. I was watching the local PBS TV station and a professor at Duke University that was a financial planner use to have a program to give free advice, which was exactly what it was worth. I was listening to him one Saturday and he said: “Based on recent tuition trends at Duke U., by 1994, the tuition would be $300,000, so you had better starting saving $zzz in CD’s at 12% so you would have the money ready in 1994.” Well in 1994, my daughter went off to the University of Virginia and the total cost was less than $10,000 per year, and at the time the tuition at Duke was $22,500. The tuition is now about $27,500 and if you can get accepted and don’t have the money, you can go free. Some of the biggest fools I have ever met were PhD’s.
The moral of this story is that the problem is not with statistics; the problem is with the fools that don’t have enough wisdom to know how to use statistics. Like making time adjustments on comp sales less than 60 days old for instance.

PS: You can’t estimate depreciation on a historic property simply because it is a one of a kind property and historic significance does not depreciate over time, it appreciates over time. It is the historical significance to be appraised and not the actual building. If there is no ability to substitute, then how can the theory substitution apply? How do you make adjustments when the most significant variable is historical significance, which is a totally subjective and residual factor unique to the subject property? You can’t but that does not mean the theory of depreciation is erroneous, it just means it does not apply in every situation. If the shoe fits, you wear it. If the shoe does not fit, don’t wear it and find one that does. If you don’t have a point of reference you will go astray!

 

[Fred]

Austin,
Here I go again, prying off the usual, ad-hominem, you-just-do-not-understand gremlins. I do not advocate leaving anything significant out of any analysis. I have no "trouble appreciating" the age-life method and do not find it too "complicated." It is obvious and simple, if not overly simplistic and presumptuous. When I was doing cost accounting, we had to break things into dozens of fixed, variable and semi-variable components. Breaking a property price into two measly pieces, one relatively fixed (land) and one mostly variable (improvement contribution) is not exactly the Labyrinth of Knossos.

Either age-life is a reasonable and sensible form of economic analysis, or it is not (regardless of what you think I think). Accruing for functional obs and economic obs that simply do not "accrue"? on a age-life schedule that varies at the whim of the practitioner? Please! The lack of direct and sound explanation speaks for itself.

Also, I am still struck that your cost approach formula subtracts land value from total value.
When I posted that type of formula in the square-foot adjustment thread
Y = (rate of) improvement contribution + land value;
you first said, you never saw anything like that. When I said it is the formula for the cost approach, you did not respond. Now you are feeding the formula back to me as the formula for the cost approach. :?: :!:

Dick,
There was a survey, like 30 years ago. I think 77% of residential report included the cost approach. (I would have to look it up to be sure). If the cost approach is less used now, I would wonder if that was the result of "appraisal theory," or the lender-clients who forced the cost approach in with 1004's and who are now forcing it out with 2055's.

 

[Austin]

Steven:
If I remember correctly the problem I had with what you were doing was subtracting land value at its highest and best use as though vacant from a data set of properties as improved without knowing if the highest and best use as improved was the same as H & BU as though vacant. There are thousands of H & BU’s for SFR vacant sites and H & BU is in a constant state of flux. If the H & BU of a site as improved with a certain classification of residence has changed over time and you subtract site value as though vacant under a different H & BU assumption you are injecting obsolescence into the existing improvements while at the same time trying to measure what is already there. If you want to measure how much water is in the bucket, you don’t start off by pouring water into the bucket so you can measure what was already there.
If I used the economic age life method to extract accrued depreciation from the market I would not take land value as though under the land’s existing H & BU, I would value the land by allocation under the assumption the existing H & BU as improved were the same as if vacant, for example, the average land to value ratio in this market is 17% excluding excess land, so the site value is replacement cost new divided by 83% less replacement cost new. That way I am not injection external obsolescence into the existing improvements and can get a true estimate of depreciation from the given data set. If you are looking for a market rate of depreciation, then the H & Bu of the sites in the data set as though vacant have to be the same as H & BU as improved within the data set used because to do otherwise would corrupt the data with external obsolescence and property conditions specific to each particular property which would yield meaningless results. We are not doing a marketing grid, we are looking for a market rate of depreciation curve. There are an infinite variety of external obsolescences affecting each particular property which can not be dealt with in the aggregate because as I stated before, you have to have a point of reference or you are a lost ball in high weeds.

 

[Dick Hemry GAA]

Steven: Definitely the latter. I use the cost approach quite often. Not on old houses but like Austin said, historical houses don't depreciate, they appreciate. That's a function of the marketplace. They ain't maken them no more. Demand is high for them. No substitutes can be economically or physically created so up goes the price then the value.

Some great gems of wisdom being imparted in this thread. I hope some of the younger appraisers get more involved and use this approach both responsibly and properly when applicable to the assignment.
Dick Hemry

 

[Steve Owen]

Steven Santora

The fact is that eff age/life ratios of 100/1,000 years will produce the exact same cost approach value as a ratio fo 5/50.

I think we may be on different tracks here. My point was simply that, for the ordinary house, you don't have to live long enough to watch it deteriorate to know its effective age - you can get that directly from the market.

If you do an appraisal on the sale of a house that is x number of years old and you do a cost approach then you find out the cost to reproduce the property. It is a simple step to determine the depreciation for that property from the cost to reproduce and the sales price (you have to take out land, of course, because it doesn't depreciate). If you do this over and over again, you will very quickly know the amount of physical depreciation to apply to all of the comforming homes in your market area - it doesn't apply to historical homes or other unusual properties.

Now, as a practical matter, to make it easily understandable, I display the incurable physical depreciation in terms of the age/life method using an anticipated life expectancy of 65 years. But, that is really not where the amount of depreciation comes from - it comes from the market, and that is also explained in the report. You are quite correct, if you used a different life expectancy and a different effective age, you would get the same math result, but it is a moot point - the depreciation came from the market.

Austin,

My grandson was born December 19, 2002. At his first medical check up I took his average daily weight and height gain and estimated that if that rate continued by his 21st birthday he would weight 17 billion pounds and be 18 feet tall.

Looks like you applied a little art to your statistical method in this case (not being a fool). I am pretty much in agreement with you. However, my point is simple - it is not necessary to use a complicated method to extract depreciation from comps in most cases. If you do a cost approach on every appraisal from a neighborhood that has a reasonable degree of conformity, regardless of the age of the house (historical and unusual homes excluded), then you will soon know the appropriate physical depreciation to apply to other homes in that area. It is not at all complicated and it is accurate, within reasonable limits, understanding that the appraiser has to accurately assess the effective age of the property being appraised to use it. Or, of course, you could just go by the book, as Terrel does - they have already done the more complicated statistical analysis, and are also accurate to the degree needed to produce a credible result.

 

[Fred]

Austin,
Your Jan 9 of 4:40 PM post speaks for itself. You said:
"That formula you cited gives me a clue though: Y= $92.5x + LV. Where did that equation come from? I have never seen anything like it before."
You are raising a tangential issue of HBU now. It was never part of my orignal square-foot question of how on earth could someone get the square foot contribution of the building without subtracting the land first, nor was HBU or part of your Jan 9 answer.


Steve O. writes,
"you don't have to live long enough to watch it deteriorate to know its effective age - you can get that directly from the market. If you do an appraisal on the sale of a house that is x number of years old and you do a cost approach then you find out the cost to reproduce the property. It is a simple step to determine the depreciation for that property from the cost to reproduce and the sales price (you have to take out land, of course, because it doesn't depreciate)"

OK, show me. Subject, is identical to every house in the neighborhood. Subject land is $40K, the imp. cost new is $160K for a total RCN of $200K. The actual age is 20 years old.
What are the market-extracted effective age, remaining life, cost approach value, etc.?

 

[Austin]

Steven:
Debating you is like chasing a ghost inside a room with no doors. You get the ghost cornered and he disappears and reappears in another corner. Lets take it one step at the time very slowly:
You say:

If you do this over and over again, you will very quickly know the amount of physical depreciation to apply to all of the comforming homes in your market area –
However, my point is simple - it is not necessary to use a complicated method to extract depreciation from comps in most cases. If you do a cost approach on every appraisal from a neighborhood that has a reasonable degree of conformity, regardless of the age of the house (historical and unusual homes excluded), then you will soon know the appropriate physical depreciation to apply to other homes in that area.

Let me tell you a dirty little secret Steven: I have been in this business for 30 years and I don’t remember the last time I didn’t know the most probable price of the subject before I ever sat down to do the appraisal. I know the answer before I leave the tax assessors office with the property data card the same way you know the rate of depreciation. Then why can’t I just tell the client the answer and be done with it? It is because USPAP requires accountability. I have to show a logical explanation of how I derived the answer. If you appraise in the same neighborhood all of the time you may very well know the exact percentage of depreciation but you have to account for it for the sake of accountability and to do that you have to support it with data and recognized methods and principles. Sorry, but even with all of my vast experience those idiots won’t take my work for it! You say the depreciation comes from the market and I agree, but prove it to me because they won’t take your word for it either! Tell me where and how you determined 65 years was the economic life. Tell me the theory and them prove it with data. It won’t do to just state: “Due to my vast experience the depreciation came form the market and you must believe me I know because I measured it once upon a time.”

"That formula you cited gives me a clue though: Y= $92.5x + LV. Where did that equation come from? I have never seen anything like it before."

You proclaimed that formula is the cost approach; it is not because there is no depreciation factor in that formula, that is what I meant when I said I have never seen anything like it before. That formula states a general theory in part but taken at face value it is meaningless.

The next thing that seems to bother you is removing land value so you can determine square foot contribution of the improvements correctly to determine accrued depreciation in the improvements. I disagree for the very reasons I explained to you on January 9th. You can’t remove the land value because most likely the H & BU of the site as though vacant may not be the same as the property as improved. I don’t mean from residential to commercial, I mean from a H & BU as a 1,000 sq ft rancher to 1,500 square foot rancher because of changes in the neighborhood. Each property is a unique economic enterprise and for that reason all value contributing factors are covariant and cannot be separated out. The site as though vacant may have a value of $40,000, but in the enterprise of the subject it may be contributing $30,000 as improved because it is not improved to the H & BU of the site. If you take the site value out based on the price as determined under its existing H & BU as though vacant status at say $40,000, then you have under stated the actual accrued depreciation by $10,000. We are not doing a H & BU analysis, we are appraising the subject property. The $/sf number including land is a pregnant number that tell the appraisal everything about that property. If you use the correct sequence of adjustments you can extract the most probable price of the property enterprise as improved because that is apparently the H & BU as of date of appraisal. We are paid to find the most probable price and not the land value contribution or accrued depreciation.