SAEE - Cost Approach and Depreciation Questions and Answers 1 — Questions and Answers
Question 1: An appraiser is valuing a historic property with unique, ornate plasterwork that is no longer commonly used. To accurately estimate the cost of the improvements, which method would be most appropriate?
- Replacement cost, because it measures the cost to build a structure with the same utility.
- Reproduction cost, because it estimates the cost to create an exact duplicate using the same materials and standards. (Correct answer)
- The unit-in-place method, as it focuses only on the cost of modern, equivalent components.
- The square foot method, as it provides a general cost based on the property's size.
Correct answer: Reproduction cost, because it estimates the cost to create an exact duplicate using the same materials and standards.
Reproduction cost is the estimated cost to construct an exact duplicate or replica of the building, using the same materials, construction standards, and quality of workmanship. This is most appropriate for historic or unique properties where the specific materials and design are integral to its value. Replacement cost, in contrast, estimates the cost to build a structure with similar utility using modern materials and methods, which would not account for the unique historic features.
Question 2: A residential property is located next to a newly constructed factory that creates significant noise and pollution. The property itself is well-maintained and has a modern layout. Which type of depreciation is most evident in this scenario?
- Physical Deterioration
- Functional Obsolescence
- Economic Obsolescence (Correct answer)
- Curable Depreciation
Correct answer: Economic Obsolescence
Economic obsolescence (also called external obsolescence) is a loss of value due to factors outside of the subject property's boundaries, such as changes in the surrounding area, environmental issues, or negative economic shifts. The factory is an external factor that negatively impacts the property's value. Functional obsolescence relates to issues within the property (e.g., poor design), and physical deterioration refers to wear and tear.
Question 3: An appraiser is using the age-life method to calculate depreciation. The improvement's replacement cost is $500,000. The appraiser determines the effective age is 15 years and the total economic life is 60 years. What is the amount of accrued depreciation?
- $100,000
- $150,000
- $125,000 (Correct answer)
- $375,000
Correct answer: $125,000
The formula for the age-life method of depreciation is: (Effective Age / Total Economic Life) * Replacement Cost. In this case, (15 years / 60 years) * $500,000 = 0.25 * $500,000 = $125,000.
Question 4: Which of the following describes the fundamental formula for the Cost Approach to valuation?
- Market Value of Comparables - Adjustments + Land Value
- (Replacement Cost New - Accrued Depreciation) + Land Value (Correct answer)
- Net Operating Income / Capitalization Rate
- Gross Rent Multiplier x Annual Rental Income
Correct answer: (Replacement Cost New - Accrued Depreciation) + Land Value
The cost approach formula is to first estimate the replacement (or reproduction) cost of the improvements as if they were new. Then, subtract all forms of accrued depreciation. Finally, add the value of the land as if it were vacant.
Question 5: A 30-year-old building has been impeccably maintained and recently modernized with a new kitchen and updated systems, making it appear and function like a 10-year-old building. In the context of depreciation, what does the '10-year' figure represent?
- Actual Age
- Chronological Age
- Total Economic Life
- Effective Age (Correct answer)
Correct answer: Effective Age
Effective age is the age a property appears to be due to its condition, maintenance, and updates, as opposed to its actual chronological age. In this case, even though the building is 30 years old (actual age), its superior condition gives it an effective age of 10 years.
Question 6: Which of the following is an example of 'curable' functional obsolescence?
- A home's foundation has a major, irreparable crack.
- The primary employer in a small town closes, causing widespread value decline.
- A house has an outdated kitchen that could be remodeled, and the cost to do so would be less than the resulting increase in value. (Correct answer)
- A new highway is built directly behind the property, creating constant noise.
Correct answer: A house has an outdated kitchen that could be remodeled, and the cost to do so would be less than the resulting increase in value.
Functional obsolescence is a loss in value due to design or features that are outdated or less desirable. It is considered 'curable' if the cost to fix the issue is less than the expected increase in property value. Remodeling an outdated kitchen is a classic example of curable functional obsolescence. The other options represent incurable physical deterioration (foundation crack) or incurable economic obsolescence (factory closure, highway noise).
SAEE - Cost Approach and Depreciation Questions and Answers 1
An appraiser is valuing a historic property with unique, ornate plasterwork that is no longer commonly used.
To accurately estimate the cost of the improvements, which method would be most appropriate?