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

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

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      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

      Answer: $4,400,000

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

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      @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.

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

      • Avatar of vincenttvincentt
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          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.

        • Avatar of vincenttvincentt
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            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.

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