The cost approach requires the identity and quantification of three types of obsolescence physical, functional and economic. Assessors frequently account only for physical depreciation (although some assessors/appraisers apply a special factor in an attempt to capture functional and economic obsolescence). Physical depreciation is dependent upon accurately determining: (1) the effective age, which is the chronological age or the weighted chronological age (if physical improvements have been made) adjusted for physical condition; and (2) the appropriate service life of the facility (some also measure and apply remaining life). Needless to say, an assessor/appraiser can increase a propertys value by misstating any one of these factors. So, the taxpayer must closely review the assessment process to make sure that each factor reflects market realities and the facilitys physical condition. It is also essential that the assessor/appraiser apply an appropriate service life that considers the major components of the facility and their interaction on the life of the facility. A purchaser of the building only recognizes value to the extent that the building can continue to produce profitable net operating income at a required rate of return. An example is an old K Mart or Sears building. Physically, for retail purposes, they are likely to have short term life, as major reparations are likely necessary to make the facilities operable in todays demanding retail environment. Nonetheless, taxing jurisdictions often apply longer physical lives that are based on the effect of such reparations (i.e., life extension); even though, they have not yet been incurred and without accounting for their cost. This artificially boosts the facilitys valuation.

Bottom line, if the taxpayer does not accurately identify and quantify the physical age, condition and service life, its property will continue to be over valued by the assessor/appraiser. If economic life is applied, the appraiser needs to recognize and quantify the other non-physical forms of obsolescence captured in the economic life to avoid double counting.

Originally posted here:
Beware of the Overstated Service Life in the Cost Approach - Lexology (registration)

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