What’s Your Number?

The pioneers in our business—developers and early practitioners of the dark-art/science of valuation theory—intended for our discipline to be recognized as one of the professions, like law or accounting. Frederick Babcock, who is considered the pioneer of appraisal theory, wrote this in his book, The Appraisal of Real Estate, published in 1924:

The appraising of real estate is a business to-day. There is, however, a decided tendency for real estate evaluation to become distinctly professional, and it is probable that in a short time real estate appraising will be recognized as a profession as truly as any other.

More than a short time has elapsed since 1924, but I fear that Babcock’s forecast has not yet come to pass; we still have a ways to go to meet that goal.

What’s Your Number?

When you appraise an average home in your market, what’s a standard estimate of the house’s total economic life? I’ve asked this question of appraisers around the country for years now, and I get a variety of answers, from 30 to 100 and everywhere in between.

Others respond by simply saying, “It’s not in the report.” I’d argue that it should be in the report, and in a sense, it is. The information is all there; you just need to take the final step: Add effective age and remaining economic life, and you get a sum—which equals total economic life.

Really, the answer itself isn’t the most important thing. What matters is how you got that answer.

Where Did You Get That Number?

The important question for appraisers is this: Where did you get your number? Or what support do you have for that number?

Most Common Responses from Appraisers

  • My Supervisor
  • Their Supervisor
  • Guessed
  • Plucked It From Air
  • What My Peers Are Doing
  • That’s Just My Opinion
  • Years of Experience

The comment section of Standard Rule 1-3 of USPAP states:

An appraiser must avoid making an unsupported assumption or premise about market area trends, effective age, and remaining life.

These responses are “unsupported assumptions,” nothing more.

I’m always amazed when I question an appraiser or assessor who is a witness in a formal hearing, and they cite “years of experience” to support their conclusions. This line just doesn’t cut it anymore. What if, when you were a trainee decades ago, your supervisor taught you an improper technique? You’ve been using this same protocol for 20 years, assuming it’s a good methodology. Wouldn’t you be an expert at using an improper technique by this time? You’d have “years of experience” doing something wrong, wouldn’t you?

Recognized Technique

Let’s review a recognized technique to support an opinion of total economic life. Before we start the math we need to review depreciation.

Here’s how the Dictionary of Real Estate Appraisal, published by The Appraisal Institute, defines depreciation:

In appraising, a loss in property value from any cause; the difference between the reproduction or replacement cost of an improvement on the effective date of the appraisal and the market value of the improvement on the same date

While I believe the first part of that definition should be changed, as depreciation is not always a loss in property value from any cause, the rest of that definition is spot on. I’ll get into that in more detail in another article, but just think for a minute: How can you lose something you never had in the first place?

Here’s another workable definition of depreciation, from page 230 of The Appraisal of Real Estate, by Frederick Morrison Babcock: “Accrued depreciation is the difference between the cost of reproducing the building new and its present-day value.”

Keep in mind that understanding depreciation is as simple as this formula: Cost minus value equals depreciation.

But before we analyze a sample sale, it’s important to understand the need to review several comparable sales and reconcile your findings. How often do you need to conduct this market research and analysis? Every time you do an appraisal? Of course not. Every month? No. What about every time you do your paired sales analysis? Maybe a little more often than that.

It’s your judgment call. Maybe you conduct this research and analysis once a year, or twice a year. Maybe you do it whenever you feel that the market has changed enough to warrant a new analysis. However you decide how often to revisit your research, do revisit it. It’s what professionals do.

Now, let’s take a look at the math:

$125,000          Sale Price

-$ 25,000         Land Value (Land Value and Depreciated Site Improvements)

$100,000          Implied Value of Improvement

 

$115,000         Cost New

         -$100,000         Improvement Value

$ 15,000          Depreciation

 

$15,000    ÷      7       =       $2,143

Dep               Age           Annual Dep.

 

$115,000          ÷      $2,143      =   54

Cost                         Dep             TEL

Reconciliation

Anytime I’m talking with a statistician, I ask how many of a sampling or data set do I need for sound results. I have heard answers as varied as 100, 60, and 31, so I suggest you analyze several sales.

Of course, you’ll get different answers to the question of total economic life. The point is to hone your analytical skills and methodology so that whatever answer you get, you can offer strong reasoning to support it.

Your judgment is the sharpest tool in your appraiser’s toolbox. You should reconcile your findings to an opinion of total economic life and, by the way, you also just obtained support for a condition or effective age adjustment. So the next time someone asks you, “Where did you get your number?” you can respond, “From the market.”

Comments

About Bryan S. Reynolds

Bryan S. Reynolds
Bryan S. Reynolds, CDEI™ is a KY/TN Certified General Real Property Appraiser, a registered agent with the TN State Board of Equalization and an AQB Certified USPAP Instructor. He has testified and appeared in various courts, planning and zoning boards as both an expert and as an agent making valuation arguments before local and state hearing officials and Administrated Law Judges. Reynolds is the owner of Bryan S. Reynolds & Associates, Reynolds Appraisal Service and a partner in Appraiser eLearning, www.appraiserelearning.com. He provides residential and commercial valuation services throughout the region and various educational offerings, mentoring, consulting and litigation support services throughout the country as well as being available for lectures and is well known for his Think Outside the "Check" Box approach.

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15 comments

  1. Avatar

    Economic Life is an accounting term and should not be used in
    appraisals. The real economic life cannot be determined, neither can the
    estimated remaining economic life. In the Cost Approach, we have to form
    some sort of depreciation (maybe on a straight line) but in reality, if
    you rebuild any home, can you use 50% depreciated materials? No. If the home is
    depreciated 50%, does that mean it would cost 50% less to rebuild? No.
    Depreciation and remaining economic life needs to be removed from the appraisal process.

    There is a possibility that we could guess the remaining physical life, but even
    then, it is only a guess. We are guessing the physical condition in the future. when we should concentrate on its condition today.

    How can you possibly calculate or prove the remaining physical life? I hope my home will last forever, but who knows. Maybe a hurricane or earthquake or termites or a tornado will hit it. I don’t know. Even home inspectors have no idea. All they do is determine the condition of the home now, not the condition 10, 20 or 50 years from now.

    • Avatar

      @Gus,
      Good catch Gus, The larger point is that there is not a lot about any approach, cost or otherwise, to appraising real property values that is real. Value is an extremely abstract notion. Maybe that is why we see a plethora of hypothetical examples in appraisal education and why the “profession” Babcock hoped for permits the use of extraordinary assumptions and hypothetical conditions (the difference between which is as big a mystery to many appraisers as economic life seems to be).

  2. Avatar
    NOLA Appraiser/Investor

    Here is a real scenario that I have noticed in some hot markets in New Orleans where value EXCEEDS cost. For example a 80-120 yr old house that is 1,500sf GLA with minimal sized porches, no parking or maybe just a driveway for 1 car. interior is nice but C3/C4 grade and It may sell for $300,000. There are similar sites sometimes 1 or two blocks away that sell for $60,000 and the cost to build a simple rectangle hardi-board clad house may be about $150,000 at $100.00 per sf. Add those two up and you have $215,000. But the house sold for $300,000 with some items like roof, kitchen etc. at 10-15years old, maybe one bath is 40years old and the other was refinished 2 years ago. The point is this house is old but people want old. How do you reconcile that with depreciation?

    • Avatar

      We had large newer houses selling for $50 per sf a few years ago when the cost to build was at least $100. You could get a 4 year old 4,000sf home for $200,000. So using the authors formula . . .

      $200,000 Sale Price
      -$ 25,000 Land Value (Land Value and Depreciated Site Improvements)
      ————-
      $175,000 Implied Value of Improvement

      $400,000 Cost New @$100 per sf
      -$175,000 Improvement Value
      ————–
      $225,000 Depreciation
      $225,000 ÷ 4 = $56,250 per year

      $175,000 ÷ $56,250 = 4 rem economic life

  3. Avatar

    This approach to estimating the remaining economic life is based on the assumption that the improvements will continue depreciating at the rate loss during the first seven years. It is all theory and doesn’t pass the ‘real life’ test.

  4. Avatar

    Economic life is a snapshot of the property as of the effective date, much like the opinion of value or housing supply numbers in the 1004MC. Its there to help the lender evaluate the risk of making the loan. Markets change, often rapidly and dramatically, so the economic life is not a life of loan prediction.
    When values decline below replacement cost external obsolescence calculations become necessary. The result should, in theory, give a good idea of the physical depreciation and remaining economic life. Sometimes easier said than done.

  5. Avatar

    Until rules are passed that require and “promote” appraisers to work together as a professional group – we will continue to be manhandled and abused as the disjointed group that we are. How can there be consistency in reporting when we are forced to compete against each other in such a manner. I promote that a federal law is mandated that each state develop and maintain a rotation panel of appraisers who meet on a regular basis. Copy the VA model and improve on it. And when someone is caught cheating or “manipulating” – have them judged by their peers and removed from the panel as needed. This would make AMC’s obsolete on day 1 – as well as promote a much more credible valuation model.

  6. Avatar

    Lenders want some assurance that the property will last longer than the loan terms. That is why REL is required. Several even ask for it on condos. When they allow it I state “greater than 30 years”, which is the typical loan term. Can I prove greater than 30 years? Easily, with qualitative data.

  7. Avatar

    Let’s face it any number
    stated will be incorrect unless you have a crystal ball. You may have a
    statistical formula to prove your number but that’s all it is, the formula will
    be no more accurate than an educated guess, you say 54 and I say 40, who’s
    right neither. No one can state with any degree of accuracy the life of a house
    it may be 40, 80, or 150. I have no degree and no letter’s behind my name but I
    think it’s a fallacy to state an unpredictable numerical economic life of a
    house. Rather let’s take a look at the antiquated form and realize that not
    every problem can be solved with statics. Why not change the verbiage to state
    “Does the subject house appear to be structurally sound, adequately
    updated both interior and exterior to
    remain in a economical state for the life of the loan barring any unforeseen
    acts of God” Yes or No. This is very simple for someone to understand and
    accomplishes the same objective without giving a number that will always be
    incorrect. Why can’t we have some common sense instead of redundant layers of
    meaningless and misleading statics?

    • Avatar

      The result of not making an effort to use a systematic and repeatable approach to establishing an opinion of effective age rather than employing a check off response to an imprecise generic comment such as “Does the subject house appear to be structurally sound, adequately updated both interior and exterior to remain in a economical state for the life of the loan barring any unforeseen acts of God” is that anyone can do exactly that and there is no accountability for having done it.

      While the survival of collateral for the life of the loan may be all that some clients are interested in, economic life of an asset is an economic principle. As Bryan advises, like it or not, lettered or not, we appraisers are economists and must use transparent diligence in measuring it and learn and employ the skills and tools available to us if we intend to enhance our usefulness to those who use appraisals and enhance our profession.

      We are required to be able to explain how we arrive at our opinions as opposed to just expressing them. That is what CU is all about and is exactly what we are expected to have been doing all along. With Fannie’s help and lack of oversight we have dumbed our contributions to opinions of value almost beyond usefulness. Pleasing the client is a small part of the job, albeit essential to the business. Getting business and pleasing clients is not our profession.
      Regardless of what your clients want to hear, you have another allegiance. Report the appraisal on a form is you must, but your work file is where the appraisal is found and where your professionalism and hard work can be measured.

      Do the work, our opinions really are worthless without it!

  8. Avatar

    Thirty years ago a Cost Approach course I took from a premier appraisal instructor
    started out with the words “This is all VOODOO”.

  9. Avatar

    I was going to elaborate
    more but I realize I’m wasting my time. You say do your work and I say I
    already spend 10 to 15 hours on each report. It seem your theory is taking the
    profession in the wrong direction, more and more work for less pay. The ideal
    that math will solve all the problems, that is why you have 20 appraisers,
    appraise the same house and you get 20 different values and they can all backup
    their value with statistics. That is also why appraises leave this business in
    droves and most that I talk to wouldn’t recommend this business to anyone. After
    all the additional layered redundancy to fix a business that was never broke,
    they want folks to get a four year degree. I often wonder what person would want
    to go through 3000 hours of training, hundreds of class room hours and a four
    year degree to work in a so called professional business to earn $300 or $400
    for 20 hours of work? My guess is not very many. And that’s my worthless
    opinion

    • Avatar
      Retired Appraiser

      Correction: $300 to $400 for 20 hours work (gross pay); more like $150 (net pay)

    • Avatar
      Retired Appraiser

      Congrats to you Herb, you are one of the few appraisers out there that has the ability to also understand the value of your own time. It’s amazes me how many appraisers today can value a property but have no clue how to accurately determine the true value of their own time.

  10. Avatar

    I enjoy trying to explain that the sticks and bricks of a 50-year old home that has interior renovations are still 50-years old, and therefore, the effective age cannot be 1-5 and the REL may still be greater than originally stated.

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