D. V. Vinogradov

FUNCTIONAL AND EXTERNAL (ECONOMIC) WEAR. COST APPROACH TO ASSESSING THE VALUE OF REAL ESTATE OBJECTS. REAL ESTATE ASSESSMENT IN ACCORDANCE WITH INTERNATIONAL STANDARDS. REAL ESTATE ECONOMICS: TUTORIAL

Functional wear is a loss in value caused by the fact that the object does not meet modern standards: in terms of its functional usefulness, architectural and aesthetic, space-planning, design solutions, livability, safety, comfort and other functional characteristics.

The following types of functional wear are distinguished:

• wear and tear is correctable (if the additional value received exceeds the cost of restoration);
• irreparable wear and tear (if the additional value received does not exceed the cost of restoration).

Correctable functional wear is measured by the cost of its correction and is caused by:

• shortcomings that require adding elements;
• deficiencies requiring replacement or modernization of elements;
• "super-improvements."

Disadvantages that require adding elements– building elements and equipment that are not present in the existing building and without which it cannot meet modern operating standards.

A quantitative measure of correctable functional deterioration due to deficiencies requiring addition is the difference between the cost of making the required additions at the time of the assessment and the cost of making the same additions if they had been made during construction of the property being assessed.

Disadvantages requiring replacement or modernization of elements– building elements and equipment that are in an existing building and still perform their functions, but no longer meet modern operational standards.

Correctable functional deterioration due to items requiring replacement or modernization is measured as the cost of existing elements, taking into account their physical deterioration, minus the cost of returning materials, plus the cost of dismantling existing elements and plus the cost of installing new elements. In this case, the cost of returning materials is defined as the cost of dismantled materials and equipment when used at other facilities.

"Super Improvements"– building elements and equipment that are present in an existing building and whose current availability is inadequate to modern operational standards.

Correctable functional wear and tear due to over-improvement is measured as the current replacement cost of the over-improvement items, minus physical wear and tear, plus the cost of dismantling and minus the return of materials, if any.

If the cost of construction is determined as replacement cost, then there are some peculiarities when determining correctable functional wear and tear. Since in this case there are no “super improvements”, there is no need to determine the share of physical wear and tear that falls on them. However, the cost of fixing “over-improvements” still needs to be considered.

Example 34. Determine the correctable functional wear and tear of an office building if it is known that:

• modern standards require the installation of an air conditioner in a building, the cost of installation of which in an existing building is 150 thousand rubles, and the cost of installation in the same building during its construction is 110 thousand rubles.
• the electrical fittings installed in the building do not meet modern market standards, while the cost of the existing electrical fittings included in the replacement cost is 350 thousand rubles, the physical wear and tear of the existing electrical fittings is 200 thousand rubles, the cost of dismantling the existing electrical fittings is 100 thousand rubles, the cost of returning materials is 10 thousand rubles, the cost of installing new electrical fittings is 190 thousand rubles.
• the building has a warehouse and an analysis of the best and most effective use showed that currently it is advisable to use this area as office space, while the current replacement cost of the warehouse space is 800 thousand rubles, physical wear and tear is 50 thousand rubles, the cost of liquidation warehouse - 80 thousand rubles.

Solution:

1. Let’s determine the amount of correctable functional wear caused by deficiencies that require adding elements (in our case, an air conditioner):

2. Let’s determine the amount of correctable functional wear caused by deficiencies, shortcomings that require replacement or modernization of elements (in our case, electrical fittings):

3. Let’s determine the amount of correctable functional wear caused by “super-improvements” (in our case, items that are functionally inherent in the warehouse):

Thus, the cost of correctable functional wear and tear of the building is:

Irreparable functional wear is caused by:

• shortcomings due to items not included in the cost of a new one, but which should be;
• shortcomings due to items included in the cost of a new one, but which should not exist;
• "super-improvements."

Incorrigible functional depreciation due to items not included in the cost of new construction is measured as the net loss of income attributable to that deficiency capitalized at the capitalization rate for buildings, minus the cost of those items if they had been included in the cost of new construction.

The calculation of irreparable functional wear and tear due to defects does not depend on whether replacement or replacement costs are taken as a basis.

Irreparable functional wear due to items that are included in the cost of new construction, but which should not exist, is measured as the current cost of the new, minus the attributable physical wear and tear, minus the cost of the added (i.e., the present value of the additional costs associated with the presence of this item).

Irreparable functional wear and tear due to “over-improvement” is determined depending on the type of value that is taken as the basis.

When replacement cost is applied, irreparable functional deterioration due to super improvements is measured as the replacement cost of the super improvements elements minus their physical depreciation, plus the present value (PV) of the owner's costs associated with the presence of the super improvements, minus any added value. At the same time, the owner’s costs include additional taxes, insurance, maintenance costs, utility bills, and the added value includes increased rent, etc. - associated with the presence of “super-improvement”.

Example 35. Determine irreparable functional wear and tear of an office building if it is known that:

• When determining the cost of new construction for the building in question, the installation of a fire extinguishing system was not taken into account (since the existing building does not have one), and it is assumed that the net loss of income caused by the lack of installation is 20 thousand rubles, the capitalization rate for buildings is 10% , and the cost of installing a fire extinguishing system during the construction of a new building is 150 thousand rubles.
• the appraised building has a high floor height, which from the market point of view on the valuation date is excessive, while the current replacement cost of the existing building is 174,900 thousand rubles, and the current replacement cost of exactly the same building, which has a normal height from the market point of view floor 172,900 thousand rubles, physical wear and tear is determined at 40%, annually the owner incurs additional costs associated with a high floor height (heating, lighting, etc.) in the amount of 500 thousand rubles, the existing capitalization ratio for buildings is 10%.

Solution:

1. Let’s determine the amount of irreparable functional wear and tear caused by deficiencies not included in the cost of new construction, but which should be based on market data on income losses caused by the absence of an element or equipment (in our case, a fire extinguishing system)

2. Let us determine the value of the incorrigible functional due to “super-improvements” (in our case, a greater floor height):

Thus, the cost of irreparable functional wear and tear of a building is:

External (economic) wear and tear– depreciation of an object due to the negative influence of the external environment in relation to the object of assessment: the market situation, easements imposed on a certain use of real estate, changes in the surrounding infrastructure and legislative decisions in the field of taxation, etc. External wear and tear of real estate, depending on the reasons that caused it, in most cases is irreparable due to the unchanged location, but in some cases it can “remove itself” due to a positive change in the surrounding market environment.

The following methods can be used to assess external wear:

• method of capitalizing loss of income attributable to external influences;
• a method for comparing sales of similar objects with and without external influences.

If there is sufficient data, the second approach is more preferable.

Method of capitalization of loss of income involves determining the loss of income of the entire property due to external influences. The building's portion of the loss is then capitalized at the capitalization rate for buildings.

Example 36. Determine the external (economic) wear and tear of the warehouse, if it is known that: net income without taking into account external factors after eliminating correctable physical and functional wear and tear is 25,000 thousand rubles; current net income after eliminating correctable physical and functional wear and tear - 21,000 thousand rubles; the cost of land is 5,000 thousand rubles, the capitalization rate for land is 10%; The capitalization rate for land is 15%.

1. Let’s determine the loss of net income due to external factors:

2. Determine the net income related to the building:

3. Determine the loss of net income related to the building:

Thus, the cost of external (economic) depreciation of the warehouse is:

Paired sales method is based on an analysis of available price information on recently sold similar properties (paired sales). It is assumed that the objects of paired sale differ from each other only by the economic depreciation identified and related to the object of assessment

Example 37. Determine the external (economic) wear and tear of a warehouse located far from the clothing market, if it is known that: the sale price of an analogue object located far from the clothing market is 600 thousand rubles; the sale price of an analogue object located close to the clothing market is 450 thousand rubles; the difference in physical and other differences between analogous objects is 60 thousand rubles.

1. Let us determine the cost of external (economic) depreciation of the warehouse:

The cost approach has a number of advantages and disadvantages.

Advantages of the cost approach:

1. When evaluating new objects, the cost approach is the most reliable.

2. This approach is appropriate or the only possible in the following cases:

• technical and economic analysis of the cost of new construction;
• justification for the need to update the existing facility;
• assessment of special purpose buildings;
• when assessing objects in “passive” sectors of the market;
• analysis of land use efficiency;
• solving problems of object insurance;
• solving tax problems;
• when agreeing on the values ​​of a property obtained by other methods.

Disadvantages of the cost approach:

1. Costs are not always equivalent to market value.
2. Attempts to achieve a more accurate assessment result are accompanied by a rapid increase in labor costs.
3. The discrepancy between the costs of purchasing the property being valued and the costs of new construction of exactly the same property, because During the appraisal process, accumulated depreciation is deducted from the construction cost.
4. The problem of calculating the cost of reproduction of old buildings.
5. The difficulty of determining the amount of accumulated wear and tear of old buildings and structures.
6. Separate assessment of land from buildings.
7. The problematic nature of land valuation in Russia.

Methods for determining economic (external) obsolescence

The final step of the cost approach is to assess economic obsolescence.

Economic obsolescence (Economic obsolescence ) – loss of value caused by external and general economic (often generating intra-industry changes) factors.

Causes of economic obsolescence may include:

• reduction in demand for some type of product;
• increased competition and shrinking market;
• changes in the structure of raw material reserves, the nature of labor costs;
• an increase in prices for raw materials, labor, transportation or utilities without a corresponding increase in the price of manufactured products;
• economic recession and inflation;
• high interest rates;
• legal restrictions, including zoning;
• environmental protection requirements at the level of state regulation.

The weakest side of the cost approach is the need to separately determine economic obsolescence. This is due to the fact that economic obsolescence is a function of external influences, which are aimed, rather, at the entire business as a whole (at all tangible and intangible assets), and not at each individual asset or group of assets. Economic obsolescence is automatically taken into account when applying the income approach, but the specificity of the cost approach, in particular, is that all types of wear and tear, including economic, are calculated separately.

Economic obsolescence is associated with the influence of external factors both in relation to the machine itself and in relation to the entire industry. It is expressed as a reduction in the useful life of a property as a result of economic forces causing changes in optimal use due to legislative changes that limit or impair property rights and changes in supply/demand relationships in the market. These factors can also be measured and expressed as a percentage of the machine's performance or potential usage. There may be cases when a machine may be 100% economically obsolete.

Economic obsolescence is usually measured based on the decline in productivity (underutilization) expressed as a percentage. It is also measured by any direct losses for individual components, such as the cost of remediation if it is remediable.

Underutilization. There is a good way to measure specific forms of wear using the cost/power ratio. In any case, when the operating load of an asset or an entire plant is less than its design capacity, we can talk about losses from underutilization. This loss reduces the capital investment from the design capacity level to the actual operating level. For example, you are evaluating equipment that is rated at 1000 tons/day, but in reality it is only operating at 600 tons/day. If you calculate equipment replacement costs based on 1000 t/d but capitalize operating losses at 600 t/d, there is a clear discrepancy. This discrepancy lies in the fact that the certain unused capacity included in the cost estimate is not reflected in any way in the operational obsolescence. This unproductive power must be taken into account during the wear assessment process.

The underutilization penalty is calculated as a percentage by comparing actual output to rated output using the following formula:

where is the power A – rated power; power IN – real performance; n – scale factor.

This relationship is based on a costing technique in which the costs of equipment of different capacities vary exponentially rather than linearly due to the effects of economies of scale. In other words, as productivity increases, costs also increase, but at a different rate. The same logic is used to calculate the value of losses from underutilization. Scale factors vary depending on the type of equipment and Labor/Material ratios. Factors range from 0.4 to just over 1.0.

Formula (5.6) was obtained as a consequence of the “Cost/Power” formula and implements the concept of “converting” unused capacity into wear and tear, expressed as a percentage. If part of the investment is not used and does not bring any benefit due to external economic reasons, then with the cost approach this should be reflected in the presence of economic obsolescence.

It is important to note that this type of underutilization adjustment can be applied to both functional and economic obsolescence. The main task of the evaluator is to identify the source (cause) of underutilization, which may relate to both progress in the technology involved in the industry and external regulations.

Continuing with the example mentioned above, let's assume that you capitalize losses due to operational obsolescence based on a production level of 600 tons/day. The actual underutilization attributed to unproductive capacity is 400 t/day. According to the principle of substitution, a prudent investor will not acquire this unproductive capacity without being able to derive some benefit from it. If an enterprise is not operating at full capacity for economic reasons, then losses due to underutilization are referred to as economic obsolescence. If there is a violation of the production balance ("bottlenecks" of production), then inefficiency may well be of a functional nature (for example, FUT). Finally, although it is not common, it may be that a plant is not operating at full capacity due to physical equipment deficiencies due to poor maintenance, deferred repairs, or a lack of spare parts. Underuse may then be due to physical wear and tear. In all cases, it is necessary to clarify all the circumstances and use the obtained data accordingly. Let's look at some examples.

Example 5.16. Estimation of reasonable market value in the use of a production line. You are looking at a 1000 unit/day production line with a service life of approximately three years and in excellent condition. Technically it meets modern standards. When talking with a client, you learn that competition from foreign manufacturers has recently increased significantly for this type of product. As a result, the client uses the equipment to produce only 750 units/day.

Let's assume that the replacement cost is $1 million for production of 1 thousand units/day, and physical depreciation is approximately 15%. Your task is to determine the existing additional wear within the cost approach.

Reduced operational (production) load is an element of economic obsolescence, since it is caused by external factors. In this case, it is advisable to make an adjustment for economic underutilization, which is calculated as follows:

The reasonable market value of this asset, obtained using the cost approach, is calculated as follows:

Replacement cost, $1,000,000

Minus physical wear and tear (15%) 150,000

Equals replacement cost less

physical wear and tear, $850,000

Minus functional obsolescence

due to excess operating costs 0

Equals replacement cost

minus FI and OFU, dollars 850,000

Minus economic obsolescence (18.2%) 154,700

Equals reasonable market value of installed equipment

in use, $ 695,300

Rounded, $700,000

There are several points in this example that are worth discussing. First, note that the adjustment for underutilization is nonlinear: a 25% reduction in productivity results in 18.2% underutilization. Secondly, this adjustment is deducted after taking into account physical wear and tear and functional obsolescence, even if there were none at all; economic obsolescence does not depend on physical wear and tear and functional obsolescence. Third, a legitimate question may be asked regarding the appropriate level of productivity for calculating cost using cost-based methods. If economic conditions are such that long-term production is 750 units/day, then it may be appropriate to calculate replacement cost on that basis. Again, specific facts and circumstances must be established and applied appropriately.

Using an underutilization adjustment is a way to measure one aspect of economic obsolescence within a cost approach. In practice, when relatively new assets that are not operating at full capacity due to economic reasons are valued, additional economic obsolescence may be present. Its quantitative measurement requires a detailed analysis of the enterprise as a whole, followed by the distribution of all losses caused by economic factors among individual assets or groups of assets.

The method for analyzing the Age/Service Life relationship in relation to determining physical wear and tear was described above. Let us note that, if certain conditions are met, this technique can also be used to measure economic wear and tear. Let's illustrate the ego with an example.

Example 5.17. Using the Age/Lifetime method.

Let's assume that we are evaluating the same car A , as in Example 5.14, which contains enough information to use the Age/Life method to calculate cumulative depreciation. The effective age of the asset is 6 years and the remaining economic life is 9 years. The asset will continue to operate for the rest of its life, hence the total economic life is 15 years (6 + 9). The cumulative wear and tear is then calculated as a ratio of 6/15, or 40%.

Note that the percentage of physical wear and tear from example 5.14 is equal to the percentage of total wear and tear in our example - 40%. The reason for the same numbers is the assumption that the remaining physical life of the asset is equal to the remaining economic life. The main difference between the two examples, however, is the application of the percentage to the corresponding level of cost of reproduction.

In example 5.14, following the principle of substitution, the object being assessed was compared with a modern equivalent. All types of wear and tear were deducted from the replacement cost, i.e. upper price level. Using the relationship between age and service life, depreciation was measured in relation to the operating conditions and usefulness of that particular asset being assessed (not comparing that asset to its modern equivalent). Accordingly, the total wear and tear of 40% in this case is correlated with the cost of reproduction.

The value of a particular asset of $78,000 is obtained as follows:

Reproduction cost, $130,000

Minus total depreciation, 40% 52,000

Reasonable market value

installed equipment

in use, $78,000

The Age/Life method assumes that the asset will be used in the future, but cannot measure the effectiveness of its use.

In reality, measuring depreciation using the Age/Life method shows the number of years an asset has already been used, and by subtracting this amount from the total estimated useful life, we obtain the number of years of remaining useful life of that asset. The underlying assumption of this method is that the utility of the asset is distributed over its life. evenly, those. The first year of operation is no different in efficiency from the last. This is obviously not true, given the fact that the equipment in the last year of its service has already suffered from physical wear and tear, functional and economic obsolescence; The ability of the equipment to make a useful contribution to the activities of the enterprise in the last year is certainly less compared to the period when it was new. Marston, Winfrey and Hempstead's book "Technological Valuation and Depreciation" presents some depreciation methods based on the compound interest (present value) technique to overcome the above-mentioned disadvantage of the age procedure. These methods take advantage of the fact that the benefit obtained from using an asset in the current year is worth more than the same benefit obtained in subsequent years. This approach provides a more accurate and realistic picture of cumulative depreciation (calculated using the Age/Life method), but is quite difficult to implement in practice and is only possible if the appraiser has the appropriate information at his disposal.

Example 5.18. Measuring economic obsolescence (decrease in sales due to a shrinking market).

Design capacity 1000 units/day (L)

Current (used) productivity 500 units/day ( IN ).

Where T = 0,6.

• Anson Marston, Robley Winfrey, Jean C. Hempstead. Engineering Valuation and Depreciation. Iowa State University Press, 1953. 508 p.

Accumulated depreciation is characterized by the loss of value of improvements from all possible causes.

Accumulated depreciation is measured by the difference between the cost of construction of similar improvements on the appraisal date and the market value of the appraised improvements. Cumulative (accumulated) depreciation includes three types of depreciation, namely:

Physical,

Functional,

External.

Physical wear and tear- this is a decrease in the value of a building due to deterioration in the physical and technical condition (strength, rigidity, attractiveness, etc.) of its individual structural elements or the entire building as a whole.

Physical wear and tear may be associated with the quality of construction, building materials used, operating conditions of the facility, climatic conditions, regularity of routine repairs, etc.

Schedule. A curve reflecting the process of accumulation of physical wear.

I is the period of intensive accumulation of wear associated with the start of operation of the facility,

II - period of stabilization, III - period of intensive accumulation of fatigue deformations.

Functional wear- this is a decrease in the value of a building due to the functional inconsistency of its individual elements or the entire building as a whole with the market needs for the property at the valuation date.

Physical and functional wear and tear manifests itself in the form of specific deficiencies in the property itself.

External (economic) wear and tear is a loss of value of a building caused by reasons external to the property. These reasons may be factors of a physical, economic, or political nature.

This type of wear is inherent in improvements due to their fixed position and, unlike physical and functional wear, does not appear in the object itself. It is associated with the external environment of the object (aging environment).

External depreciation is measured by the capitalized value of rental losses, estimated using the gross rent multiplier.

Physical and functional wear and tear may or may not be removable at the valuation date.

Removable is wear and tear, the causes of which are economically feasible to eliminate, that is, when the increase in the value of the object after the elimination of the defect covers the costs associated with this elimination.

Fatal depreciation is considered to be the cost of eliminating which is greater than the increase in the value of the object associated with the elimination of the identified defect.

Thus, the test for the nature of wear (removable or irreparable) is the conclusion - whether the restored (repaired) elements have additional market value, and whether the repair costs are covered.

External (economic) wear and tear is always considered irreparable. It is directly related to the location of the object being assessed. The reasons that cause it are external to the property and cannot be eliminated by the owner of the property being assessed.

Methods for determining accumulated wear.

There are the following methods for determining accumulated wear:

straight:

• lifetime method;
• partitioning method;

and indirect:

• extraction method.

Lifetime method.

Physical lifespan (Tf)- this is the period of time during which the building exists and is suitable for use (housing).

Economic life (Tek) is the period of time during which the building generates profit.

Effective age (Teff)- determined on the basis of an expert assessment of the appearance of the house, taking into account its condition, design and economic factors affecting the value of the property being assessed.

Remaining economic life (Toast)- this is the period of time determined by the difference Tek - Tef.

Chronological age (Thr)- determined as of the assessment date from the moment the facility is put into operation.

Schedule. Estimation of cumulative wear and tear.

Calculation of accumulated depreciation by the life-span method assumes that the ratio of effective age to typical economic life is equal to the ratio of accumulated depreciation to the cost of reproduction.

This method can be used for:

• determining the wear and tear of the entire building;
• its individual structural elements.

The necessary background information on determining the standard lifespan of a building and its individual elements can be obtained from standard reference books

In the process of estimating accumulated depreciation using the life cycle method, the question arises of determining the period of the remaining economic life. In this case, one should proceed from the following suggestions:

Splitting method.

Let's consider how accumulated wear is determined when applying the partitioning method, which uses the assumption of independence of various types of wear as a base one.

External wear and tear of real estate, depending on the reasons that caused it, in most cases is irreparable due to the unchanged location, but in some cases it can “remove itself” due to a positive change in the surrounding market environment. Methods for determining external wear are shown in Fig. 4.9.

Rice. 4.9. Methods for determining external wear

Loss capitalization method In the rental payment, the calculation of external wear and tear is carried out similarly to the calculation of functional irreparable wear.

Paired sales method is based on an analysis of available price information on recently sold similar properties (paired sales). It is assumed that the objects of paired sale differ from each other only by the economic depreciation identified and related to the object of evaluation (Table 4.8).

Table 4.8

An example of calculating external wear and tear using the paired sales method

Example. The physical wear and tear of the assessed building is 40%. According to the redevelopment plan, the building is subject to demolition after two years from the date of assessment.

During the inspection of the object by an expert, the following indicators were determined:

1) the effective age of the assessed building is 30 years;

2) the remaining economic life is 60 years.

Accumulated wear without taking into account the action of external factors is calculated using formula (4.1):

.

Wear taking into account the action of external factors:

The share of possible consideration of other types of wear in this result is extremely small, which allows us to consider the result obtained as external wear. A sharp reduction in the remaining economic life of a building leads to a decrease in investment attractiveness and, as a consequence, a precipitous drop in the likely sale price.

In such cases, the purpose of the valuation is not to calculate the full ownership rights to the building being valued, but short-term lease rights for the remaining economic (physical) life, provided that the potential investor sees any benefit from this acquisition.

4.6. An example of assessing the value of a property
cost-effective approach

In table 4.9 shows an example of calculating the value of a property using the cost approach.

Table 4.9

Calculating the value of a property using a cost approach

Line no.	Estimated indicators	Costs, thousand rubles
	Cost of land	230 000
	Replacement cost	500 000
	Developer profit (30%)	150 000
	Total construction costs (line 2 + line 3)	650 000
	Impairment due to recoverable physical wear and tear of short-lived items	10 200
	Impairment due to irreversible wear and tear of short-lived items	10 925
	Impairment due to irreversible physical wear and tear of long-lived items	146 990
	Total impairment due to depreciation (line 5 + line 6 + line 7)	168 115
	Impairment due to reversible functional wear and tear	38 000
	Impairment due to irreversible functional wear and tear	96 000

To increase the accuracy of calculation procedures for both determining replacement cost and calculating wear and tear, a reasonable compilation of several methods for calculating these indicators is necessary.

It must be taken into account that in many cases the cost approach to real estate valuation does not reflect market value, since the investor’s costs do not always create market value due to the difference in the costs of recreating comparable objects, and, on the contrary, the value created is not always adequate to the costs incurred. This applies primarily to income-producing real estate.

5. Income approach to real estate valuation

5.1. General provisions

The income approach is a set of methods for assessing the value of real estate, based on determining the current value of the income expected from it.

The income approach is used to determine:

Investment value, since a potential investor will not pay more for an object than the present value of future income from this object;

Market value.

The main prerequisite for calculating the cost using this approach is the rental of the property. Capitalization of income is carried out to convert future income from real estate into current value.

Income capitalization is the process of recalculating a stream of future income into a final value equal to the sum of their current values.

The income approach is based on the fact that the value of the property in which capital is invested must correspond to the current assessment of the quality and quantity of income that this property is capable of generating, taking into account the risks characteristic of both the property being valued and the region.

The essence of the income approach is to estimate the current (today's) value of future benefits that are expected to be brought by the operation and possible future sale of real estate, through capitalization of income.

The income approach is used only for the valuation of income-producing real estate, i.e. such real estate, the sole purpose of which is to generate income, and is based on the following principles of real estate valuation:

The principle of expectation for this approach is the main method-forming principle (the cost of an income-generating object is determined by the current value of the future income that this object will bring). The typical investor or buyer purchases real estate with the expectation of receiving future income or benefits from it. Thus, the value of an asset can be defined as its ability to generate income in the future. The time factor also applies here, and the amount of future income must be brought to zero point in time by capitalizing income;

The principle of substitution (the value of a property tends to be set at the level of the effective capital investment required to acquire a comparable, replacement property that will generate the desired profit). The maximum value of an asset should not exceed the lowest price at which another similar asset with an equivalent return can be purchased.

Estimating market value using the income approach is based on converting the income that the subject asset is expected to generate over the remainder of its economic life into value. From a theoretical point of view, the source of income can be anything: rent, sale, dividends, profit. The main thing is that it is a product of the asset being valued. Using this approach, it is possible and appropriate to evaluate those assets that are used or can be used to generate income (real estate, shares, bonds, bills, intangible assets, etc.).

The higher the income potential of the asset being valued, the higher its value. In this case, the analysis of income should be carried out throughout the remaining economic life of the asset, provided that it is used during this period in the most effective way.

General concepts and terminology

Depreciation is characterized by a decrease in the usefulness of a property, its consumer attractiveness from the point of view of a potential investor and is expressed in a decrease in value (depreciation) under the influence of various factors over time. As the facility is used, the parameters characterizing the structural reliability of buildings and structures, as well as their functional compliance with current and, especially, future use associated with human life, gradually deteriorate. In addition, the value of real estate is no less influenced by external factors caused by changes in the market environment, the imposition of restrictions on certain uses of buildings, etc.

Depreciation (I) is usually measured as a percentage, and the monetary expression of depreciation is depreciation (O).

Depending on the reasons causing the depreciation of a property, the following types of wear and tear are distinguished: physical, functional and external.

Classification of depreciation of real estate objects

Each type of wear is characterized by its division: removable and irremovable. In the most general case, removable wear is called wear, the elimination of which is physically possible and economically feasible. At the same time, economic feasibility lies in the fact that the costs incurred to eliminate one or another type of wear and tear should help increase the value of the object as a whole.

When all designated types of wear and tear are identified, they speak of the total accumulated wear and tear of the property. In monetary terms, the cumulative wear and tear is the difference between the replacement cost and the market price of the property being valued. Based on the essence of these definitions, it can be argued that the total accumulated wear and tear is, first of all, a function of the lifetime of the object. Taking this circumstance into account, let us consider the essence of the main evaluative concepts characterizing this indicator:

Physical life buildings (FZ)- determined by the period of operation of the building, during which the condition of the load-bearing structural elements of the building meets certain criteria (structural reliability, physical durability, etc.). The physical life of an object is laid down during construction and depends on the capital group of the buildings. Physical life ends when the object is demolished.

Chronological age (CA) - this is the period of time that has passed from the date the facility was put into operation until the date of assessment.

Economic Life (EJ) - determined by the operating time during which the object generates income. During this period, improvements made contribute to the value of the property. The economic life of an object ends when the operation of the object cannot generate the income indicated by the corresponding rate for comparable objects in this segment of the real estate market. In this case, the improvements made no longer contribute to the value of the object due to its general wear and tear.

Effective age (EA) - determined on the basis of the chronological age of the building, taking into account its technical condition and the economic factors prevailing on the valuation date that influence the value of the assessed object. Depending on the operating characteristics of the building, the effective age may differ from the chronological age up or down. In the case of normal (typical) operation of a building, the effective age is usually equal to the chronological age.

Remaining Economic Life (REL) of a building is the period of time from the date of valuation until the end of its economic life.

The subjectivity of determining such indicators as economic life and effective age requires the appraiser to be quite highly qualified and have considerable practical experience. Depreciation in valuation practice must be distinguished in meaning from a similar term used in accounting (depreciation). The meaning of depreciation in accounting is the regular distribution of initial investments in an object (book value) for the entire period of its operation in accordance with the norms of depreciation charges for the “full” restoration of fixed assets. Estimated depreciation is one of the main parameters that allows you to calculate the current (actual) value of an object of assessment on a specific date.

Physical wear and tear

Physical wear and tear is the gradual loss of the technical and operational qualities of an object originally laid down during construction under the influence of natural and climatic factors, as well as human activity.

The following methods for calculating the physical deterioration of buildings are distinguished:

normative (for residential buildings);

cost;

lifetime method.

Standard method for calculating physical wear and tear

The normative method for calculating physical wear and tear involves the use of various normative instructions at the interindustry or departmental level. As an example of such instructions, one can name the “Rules for assessing the physical deterioration of residential buildings” VSN 53-86 of Gosgrazhdanstroy (State Committee for Civil Construction and Architecture under GOSSTROE of the USSR. Moscow, 1990), used by the Bureau of Technical Inventory for the purpose of assessing the physical deterioration of residential buildings during technical inventory, planning major repairs of the housing stock, regardless of its departmental affiliation.

These rules describe the physical wear and tear of various structural elements of buildings and their assessment.

The physical wear and tear of a building should be determined using the formula:

Fф = ,

Where Ff- physical wear and tear of the building, (%);

Fi- physical wear and tear i th structural element (%);

Li- coefficient corresponding to the share of replacement cost i th structural element in the total replacement cost of the building;

n- the number of structural elements in the building.

The shares of the replacement cost of individual structures, elements and systems in the total replacement cost of the building (in%) are usually taken according to aggregated indicators of the replacement cost of residential buildings, approved in the prescribed manner, and for structures, elements and systems that do not have approved indicators - according to their estimate cost.

The described technique is used exclusively in domestic practice. Despite all its clarity and persuasiveness, it has the following disadvantages:

due to its “normativity”, it initially cannot take into account the atypical operating conditions of the object;

labor-intensive application due to the required detailing of the structural elements of the building;

inability to measure functional and external wear;

subjectivity of specific weighing of structural elements.

Cost method for determining physical wear and tear

Physical wear and tear at the time of its assessment is expressed by the ratio of the cost of objectively necessary repair measures to eliminate damage to structures, an element, a system or a building as a whole, and their replacement cost.

The essence of the cost method for determining physical depreciation is to determine the costs of recreating building elements.

The described methodology allows you to calculate the wear and tear of elements and the building as a whole immediately in cost terms, which is more preferable than other methods for calculating physical wear and tear. In addition, since the impairment calculation is based on the reasonable actual cost of bringing worn-out items to “substantially new condition,” the result under this approach can be considered fairly accurate. Among the disadvantages inherent in this method, it is necessary to note the mandatory detail and accuracy of calculating the costs of repairing worn-out elements of the building.

Determination of physical deterioration of buildings using the lifespan method

Based on the essence of the previously discussed basic evaluative concepts characterizing the total accumulated wear and tear of a building from the point of view of its operation time, it can be argued that physical wear and tear, effective age and economic life are in a certain ratio. This relationship can be expressed by the following formula:

I(%)=(EV/FJ)(100 – (EV/OV+OSFJ))/100, (1)

Where AND(%)- wear as a percentage;

EV- effective age, determined by an expert based on the technical condition of the elements or the building as a whole;

VF- typical physical life span;

OSFJ- the remaining period of physical life.

In this case, physical depreciation can be calculated both for individual elements of the building with the subsequent summation of the calculated impairments, and for the building as a whole. Sometimes, for approximate calculations of wear and tear, appraisers may also use a simplified formula that takes into account the relationship between the chronological age and physical life of the building:

I(%) = (HV/VF)/100 , (2)

Where AND(%)- wear as a percentage;

VF- typical physical life span.

The application of this formula (2) is also relevant when calculating percentage adjustments for wear and tear in compared objects (comparative sales method), when it is not possible for the appraiser to inspect selected analogues to determine the indicators used in the calculation formula (1).

The percentage of depreciation of elements or the building as a whole calculated in this way can be translated into monetary terms (depreciation):

O= BC *(I/100),

Where AND- wear as a percentage;

Sun- replacement cost.

As noted earlier, physical wear and tear is divided into removable and irreparable. In addition, in practice, elements of a structure that have removable and irreparable physical wear are divided into long-lived and short-lived.

Short-lived elements- elements that have a shorter lifespan than the entire structure (roofing, plumbing equipment, etc.).

For long-lived elements, the expected lifespan is comparable to the lifespan of the entire structure (foundation, load-bearing walls, etc.).

Removable physical wear of short-lived elements

The cause of removable physical wear and tear is the natural wear and tear of building elements over time, as well as careless operation. In this case, the selling price of the building is reduced by the corresponding impairment, since the future owner will need to carry out “previously deferred repairs” in order to restore the normal operational characteristics of the structure (routine repairs of the interior, restoration of areas of leaking roofing, etc.). This assumes that the items are restored to a “virtually new” condition.

So, removable physical wear and tear in monetary terms is defined as the “cost of deferred repairs,” i.e. costs of bringing the object to a condition equivalent to the original one.

Unrecoverable physical wear of components with a short lifespan

Unrecoverable physical wear of short-life components represents the cost of restoring these rapidly wearing components and is determined by the difference between the replacement cost and the amount of removable wear multiplied by the ratio of the chronological age and the physical life of these elements.

Removable physical wear of elements with a long lifespan

Removable physical wear of elements with a long life in cost terms can be determined by the reasonable costs of its elimination, similar to the removable physical wear of elements with a short life.

Irremovable physical wear of long-life elements

Irremovable physical deterioration of long-life elements is determined by the difference between the replacement cost of the entire building and the sum of removable and irreparable deterioration, multiplied by the ratio of the chronological age and the physical life of the building.

Functional wear

Signs of functional wear and tear in the building being assessed, as a rule, are the non-compliance of its space-planning and/or design solutions with modern standards, including various equipment necessary for the normal operation of the structure in accordance with its current or intended use.

Depending on the physical possibility and economic feasibility of eliminating the causes that caused functional wear, it is divided into removable and irreparable. The cost expression of functional wear and tear is the difference between the cost of reproduction and the cost of replacement, since the calculation of the latter, based on its definition, obviously excludes functional wear from consideration.

Removable functional wear

Removable functional wear and tear is usually determined by the cost of necessary reconstruction to facilitate more efficient operation of the property.

Reversible functional wear is considered to be caused by:

shortcomings that require adding elements,

deficiencies requiring replacement or modernization of elements,

super improvements.

Deficiencies that require addition include elements of the building and equipment that do not exist in the existing environment and without which it cannot meet modern performance standards. Depreciation due to these items is measured by the cost of adding these items, including their installation.

Disadvantages that require replacement or modernization of elements include items that still perform their functions, but no longer meet modern standards (water and gas meters, etc.). Depreciation for these items is measured by the cost of existing elements, taking into account their physical wear and tear, minus the cost of returning materials, plus the cost of dismantling existing elements and plus the cost of installing new elements. In this case, the cost of returning materials is determined as the cost of dismantled materials and equipment when used at other facilities (revisable residual value).

Super-improvements include positions and elements of the structure, the availability of which is currently inadequate to modern requirements of market standards. Removable functional wear and tear in this case is measured as the current replacement cost of the “over-improvement” items minus physical wear and tear, plus the cost of dismantling and minus the salvage value of the dismantled elements.

An example of over-improvement would be a situation where the owner of a house, adapting it for himself, made some changes for his own convenience (investment value) that were not adequate from the point of view of a typical user. These include, for example, the redevelopment of the usable area of ​​​​premises for a specific use, determined by the owner’s hobbies or his occupation. Removable functional wear in such a situation is determined by the current cost of bringing the changed elements to their original state. In addition, the concept of over-improvement is closely related to the segment of the real estate market, where the same improvements can be considered both appropriate for a specific segment and excessive from the point of view of a typical user.

Unrecoverable functional wear

Irremovable functional wear and tear is usually caused by outdated space-planning and/or structural characteristics of the buildings being assessed relative to modern construction standards. First of all, the economic inexpediency of spending money on eliminating these shortcomings allows us to judge the sign of irreparable functional wear. In addition, it is necessary to take into account the market conditions prevailing on the date of assessment in order for the building to adequately match its architectural purpose to its purpose.

However, depending on the specific situation, the cost of irreparable functional wear and tear can be determined in two ways: both as a capitalized loss in rent, and as a capitalization of excess operating costs necessary to maintain the building in proper order. To determine the necessary calculation indicators (rental rates, capitalization rates, etc.), adjusted data on comparable analogues are used. In this case, the selected analogues should not have signs of irreparable functional wear identified in the object of assessment. In addition, the total income generated by the property complex (building and land) as a whole and expressed in rent must be divided into two components accordingly. To allocate part of the income attributable to the building, you can use the investment balance method for the building or the method of analyzing the ratio of the value of the land plot and the total sales price of the property complex.

External (economic) wear and tear

External depreciation is the depreciation of an object due to the negative influence of the external environment in relation to the object of assessment: the market situation, easements imposed on a certain use of real estate, changes in the surrounding infrastructure, legislative decisions in the field of taxation, etc. External wear and tear of real estate, depending on the reasons that caused it, in most cases is irreparable due to the unchanged location, but in some cases it can “remove itself” due to a positive change in the surrounding market environment.

The following methods can be used to assess external wear:

capitalization of rental losses;

comparative sales (paired sales);

economic life span.

The calculation of external wear and tear using the method of capitalizing losses in rent is carried out similarly to the calculation of functional irreparable wear and tear.