CFA CFA Level 2 Private Real Estate – Cost Approach (why no adjustment?)

# Private Real Estate – Cost Approach (why no adjustment?)

• Author
Posts
• 7

Guys can you help with this question. I don’t understand why there is no adjustment for incurable physical depreciation.

Value Property B using the cost approach

Size (sqm) = 4,000
Lease type = Net
Expected LTV ratio = 75%
Effective age = 25
Remaining economic life = 65

Rental income (at full occupancy) = \$700,000
Other income = \$35,000
Vacancy and collection loss = \$0
Property management fee = \$25,000
Other op expense = \$0
Discount rate = 12.5%
Growth rate = 3.5%

Market value of land = \$2,000,000
Replacement cost of building including developer’s profit = \$7,500,000
Deterioration – Curable and Incurable \$3,750,000

Obsolescence:
Functional \$350,000
Locational \$500,000
Economic \$500,000

Value = \$2,000,000 + \$7,500,000 – \$3,750,000 – \$350,000 – \$500,000 – \$500,000

• 5

@vincentt I thought the curable part of the \$3,750,000 amount will need to be deducted for depreciation. But it does not appear to be required here. Lost.

• vincentt
Participant
• CFA Level 3
3

On the top of my head, incurable is ‘covered’ in the calculation to deduct (effective age / remaining economic life) * (cost to replace – curable).

• vincentt
Participant
• CFA Level 3
3

ahh i thought you are referring to one of the Q in schweser’s mock because those figures look familiar.

Basically the formula is as follows ( I couldn’t calculate your example because ur incurable is included in the curable figure):

(Replacement cost + developer’s profit)
– curable deterioration
– (effective age / total economic life) * (replacement cost + developer’s profit – curable deterioration)
– functional obsolescence
– location obsolescence
– economic obsolescence
+ market value of land

Again, I’ve double checked and i can confirm that incurable is indeed effective age / total economic life so if incurable increases the effective age increases as well.

• vincentt
Participant
• CFA Level 3
0

I need to look at the question again when i’m back and get back to you on that.

From what I could remember, you deduct (effective age / remaining economic life) * (developer’s cost and profit – curable) from “developer’s cost and profit” before proceeding to other items.