180 Part 3 Market Valuation and Appraisal

Accrued Depreciation
Accrued depreciation is the difference between the current market value of a building (or
improvement) and the total cost to construct it new.11 This difference generally increases
with building age and is attributed to three elements: physical deterioration, functional
obsolescence, and external obsolescence.
Physical deterioration represents the loss in value of a building over time associated
with the aging and decay of its physical condition. This occurs in both short-lived items
(e.g., carpeting, roofing materials, appliances) and long-lived items (e.g., roof framing,
windows, doors, stairs, foundation). Simply stated, older buildings are worth less than oth-
erwise equivalent newer structures.
Functional obsolescence is a loss in the value of a structure due to changes in tastes,
preferences, technical building innovations, or market standards. Similar to physical
deterioration, functional obsolescence tends to be associated with the passage of time.
Newer building materials, construction techniques, and designs, coupled with changing
consumer tastes and preferences, generally make older buildings less desirable to tenants
and thus not as valuable as newer buildings. However, newer buildings can suffer from
functional obsolescence. For example, a new home without a large master bathroom suite
is functionally obsolete in many markets today. Examples of curable functional obsoles-
cence include outdated fixtures, too few electrical outlets, lack of bookcases, too-high
ceilings, and lack of insulation. Examples of functional obsolescence that are often
incurable include a poor exterior design or interior floor plan. Note that the use of
replacement cost, rather than reproduction cost, eliminates the need to estimate some
forms of functional obsolescence.
Finally, external obsolescence reflects the loss in market value due to influences
external to the site. Simply stated, external obsolescence results from a deterioration in the
subject property’s neighborhood. Noxious odors, unpleasant sights, and increased traffic
due to more intensive uses (e.g., commercial and industrial) introduced into a residential
neighborhood are examples of this external obsolescence.

Example 7-2 2380 Appletree Court

To estimate the value of 2380 Appletree Court using the cost approach, an appraiser esti-
mates the current cost of the building improvements, the total accrued depreciation, and
the value of the site (and any site improvements). The appraiser’s estimates are shown in
Exhibit 7-11.
The reproduction cost estimates are based on information supplied by a private cost
estimating firm and data obtained from local building contractors. The living area of the
dwelling is estimated to cost $121,520 to replace new (1,960 sq. ft. × $62 per sq. ft.). The
cost of the garage ($8,800) and appliances ($2,400) is added, resulting in total estimated
construction costs of $132,720. Physical depreciation of the existing property is estimated
at 5 percent of the total replacement costs ($6,636 = $132,720 × 0.05). The appraiser
concludes that the property has not suffered any functional or external obsolescence. This
results in a depreciated value of $126,084 ($132,720 − $6,636). The site value is estimated
to be $40,000. Landscaping and other miscellaneous site improvements are estimated to
have a current value of $4,000. Thus, the indicated value of the subject property using the

11. It is important to note that the appraisal concept of depreciation differs substantially from the accounting
concept used for income tax calculation. The appraisal term is associated with actual reductions in market value,
while the term used in calculating taxable income deals with allowable reductions to a property’s book value, or
depreciable basis (see Chapter 20).
 INDUSTRY ISSUES 7-2

“A
utomated valuation models” or However, several limitations affect the between various sale types, such as fore-
AVMs are computer programs potential accuracy of AVMs, including the closures and traditional sales. For exam-
that try to replicate work done complexity and variation of homes and ple, it could compare a well-kept
by human real estate appraisers. This is their locations as well as inaccurate data traditional sale to a severely damaged
accomplished by combining a home’s about the subject and comparable proper- foreclosed property sale.
­physical and locational characteristics and ties. A home’s value isn’t simply the by- As a result, many lenders prefer to have
nearby sales trends into a computer- product of a traceable mix of lot sizes, an appraiser involved, but at
generated estimate of market value. AVMs bedroom counts, comparable sales prices, a lower cost than a tra-
use sophisticated multiple regression tech- and other factors. Even the deepest real ditional appraisal.
niques and a database of thousands—or estate database can’t effectively juggle Some industry Do Prices
millions—of sale transactions to determine the intangibles altering a home’s value, analysts are Compute?
the market value of the subject home’s from its condition inside and out to the therefore pre- Using Statistical
physical and locational attributes and there- quality of the view. For example, AVMs dicting an
fore its predicted price/value. This value can’t detect serious structural problems, increased use Models
estimate can then be reviewed by an termite damage, or hazardous wiring. This of a hybrid to Estimate
appraiser, or the appraisal process can be can lead to an overstated value for a prop- methodology Home Values
deemed complete. erty in bad condition or an understated that combines
Traditional appraisals provided by value for a home in superior condition AVM technology and
licensed real estate appraisers cost with many upgrades. Furthermore, AVMs the use of an appraiser
$300–$400 a home. Appraisals generated are largely dependent on public record (i.e., actual “boots on the ground”) to verify
by AVMs are one-tenth the cost—or less. databases, and if those databases have data and the validity of assumptions.
Plus, automated models are quick, making incorrect or outdated information, the sta-
large-scale reviews of numerous home tistical model will return an inaccurate val-
­values financially feasible. uation. Also, AVMs may not distinguish

cost approach is $170,084, rounded to $170,100. Declines in market value associated with
accrued depreciation are difficult to estimate in practice. This explains why the other meth-
ods of valuation are relied upon more in most appraisal assignments.

Exhibit 7-11 2380 Appletree Court: Cost Approach Summary

Reproduction cost of improvement

Living area (conditioned space) $121,520
Garage area 8,800
Appliances, porch, patio areas 2,400 $132,720
Less: Depreciation of improvement
Physical deterioration 6,636
Functional obsolescence 0
External obsolescence 0 −6,636
Depreciated value of improvements $126,084
Plus: Value of the site 40,000
Plus: Depreciated Value of site improvement 4,000
Indicated value by cost approach (rounded) $170,100

✓ Concept Check
7.10 Of the three basic steps in the cost approach to valuation—estimate
replacement cost, estimate accrued depreciation, and estimate site
value—which is generally the most difficult and why?

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182 Part 3 Market Valuation and Appraisal

Final Reconciliation
In determining the final estimate of the subject’s market value, an appraiser considers and
weighs the reliability of the indicated values from different approaches, and the relevance
of the approaches to the valuation of the subject property. In the Appletree Court example,
the appraiser has produced estimated market values using the sales comparison approach
and the cost approach of $167,900, and $170,100, respectively. The appraiser has deter-
mined that owing to the reliability of the comparable sales data and the applicability of
the approach to residential properties, the sales comparison approach yields the most
reliable indicator of value. Therefore, all weight is placed on this approach in reconciling
the value indicators. Thus, the final estimate of value of the residence located at 2380
Appletree Court is $167,900.
The appraisal of a residence, as described using the Appletree Court example, is gener-
ally required to obtain financing when purchasing a property. Lenders usually ask apprais-
ers to submit their independent value opinion for a home by completing a Uniform
Residential Appraisal Report (URAR) form. A sample URAR is shown for the Appletree
Court property in Exhibit 7-12.

EXPLORE THE WEB

The Emergence of Online Appraisal Tools
Numerous private firms are now offering online automated valuation models (AVMs) and/or comparable sales
reports for borrowers, lenders, and other participants in the single-family residential market interested in homes
values. Real Data (www.realdata.com/ls/online-real-estate-valuation-services-compared.shtml), a provider of real
estate investment software, compiles a list of companies that have developed online valuation resources, including
AVMs based on multiple regression analysis (MRA). One of the authors paid $29.95 to have his home appraised
online by the Electronic Appraiser (www.electronic appraiser.com). Just prior to this, the author’s home had been
appraised by a traditional fee appraiser for the purposes of a mortgage refinancing. The online AVM returned a
value estimate 7 percent greater than the traditional appraiser’s estimate.
Search the provided by Real Data for an AVM model available for use free of charge. Use this website to obtain
an estimate of market value for a relative’s (or your) home. We recommend that you visit www.zillow.com for a
free, instant valuation of many U.S. homes. Type in the address for your parent’s home or one of your neighbors
and surprise them with your market knowledge.