OAR 150-308-0280: Measuring Functional Obsolescence in Industrial Property

(1) The procedure for estimating functional obsolescence for industrial property in the reproduction cost approach is as follows: (a) The total functional obsolescence equals: (A) The physically depreciated reproduction cost of the property with a deficiency requiring a substitution or modernization, or a superadequacy, less (B) The physically depreciated cost of the replacement property with a deficiency requiring a substitution or modernization, or a superadequacy, plus (C) The cost to cure or the value of the loss (if less). (b) For an industrial property with a deficiency requiring an addition follow the same steps as listed in subsection (1)(a), except step (A) equals zero. (c) The result of (1)(a) equals the total functional obsolescence deduction in the reproduction cost approach attributable to the property with a deficiency or superadequacy. (d) In specific situations, the procedure in subsection (1) can be simplified: (A) For curable functional obsolescence caused by a deficiency requiring a substitution or modernization, or a superadequacy, functional obsolescence equals the physically depreciated reproduction cost of the property with a deficiency or superadequacy plus the excess cost to cure. (B) For curable functional obsolescence caused by a deficiency requiring an addition, functional obsolescence equals the excess cost to cure. (e) For purposes of measuring functional obsolescence, the property with a deficiency or superadequacy in subsection (1) of this rule can be the entire subject property or one or more portions of the property that are being analyzed for the existence of functional obsolescence. If the entire property has multiple deficiencies or superadequacies, multiple applications of the procedure in subsection (1) of this rule may be required to measure the total functional obsolescence. (f) Some methods of measuring depreciation may capture more than just physical depreciation. The depreciation measured may include elements of functional and external obsolescence. (A) If in subsection (1)(a)(A) an age-life method is used to estimate the total depreciation of the property with a deficiency or superadequacy, no additional functional obsolescence should be deducted from the depreciated reproduction cost of the individual assets. (B) If in subsection (1)(a)(A) the selling price of used equipment is used to estimate the depreciation of the property with a deficiency or superadequacy, no additional functional obsolescence should be deducted from the depreciated reproduction cost of the individual assets. (C) In situations where all functional obsolescence of individual assets is fully captured by the depreciation method used, there may be additional functional obsolescence due to the assemblage of the individual assets into the layout of the property. Functional obsolescence due to layout can be accurately measured using the procedures described in subsection (1) of this rule. However, care must be taken to avoid double counting the functional obsolescence. (2) The deduction for functional obsolescence in the replacement cost approach equals the cost to cure or the value of the loss (if less). (a) When using the procedure in subsection (1)(a) of this rule to estimate the deduction for functional obsolescence in the replacement cost approach, steps (A) and (B) must equal zero ($0). (b) When using consistent estimates of reproduction and replacement cost new, physical depreciation, and functional and external obsolescence, the market value indicator from replacement cost approach must equal the market value indicator from the reproduction cost approach. (see example 3) (3) Definitions: (a) The reproduction cost approach is an appraisal method for estimating market value of the subject property. The formula for this method is: Market Value equals the Reproduction Cost New less physical depreciation less functional obsolescence less external obsolescence. (A) The reproduction cost new is the cost to construct a new replica of the subject property as of the appraisal date using the same materials, design, layout, quality of workmanship and embodying the deficiencies and superadequacies of the subject property. (B) The appraisal approach where the appraiser estimates the depreciation based on the selling prices of used equipment is a reproduction cost approach when the used prices utilized in the appraisal are for pieces of equipment that are replicas of the subject equipment. The formula for this method is: Market Value equals the Reproduction Cost New less the depreciation from used equipment prices less the functional and external obsolescence not captured in the used equipment prices. (C) The appraisal approach where the appraiser estimates the depreciation using an age-life method is a reproduction cost approach when the starting point is the reproduction cost new. The formula for this method is: Market Value equals the Reproduction Cost New less the depreciation from an age-life analysis less the functional and external obsolescence not captured in the age-life analysis. (b) The replacement cost approach is an appraisal method for estimating the market value of the subject property as of the appraisal date. The formula for this method is: Market Value equals the Replacement Cost New less physical depreciation less the cost to cure (or the value of the loss, if less) less external obsolescence. The replacement cost new is the cost, as of the appraisal date, to construct a property having equivalent utility to the subject property but built with the most cost-effective materials, design, and layout. The most cost effective materials, design, and layout is that combination of investment (cash out-flows) and the present value of anticipated after tax net income (cash in-flows) that produces the highest net present value. (c) Functional Obsolescence is a loss in market value of a subject property when there is a reasonable feasibility of a typical prospective purchaser acquiring, without undue delay, a replacement property possessing an equivalent utility but is more cost-effective in terms of design, materials, or equipment. Functional obsolescence exists only by a comparison between the subject and the replacement property. There is no loss in value due to functional obsolescence unless the physically depreciated reproduction cost of the subject property minus the physically depreciated replacement cost of the replacement property plus the cost to cure (or value of the loss, if less) is greater than zero. (A) Functional obsolescence due to a deficiency requiring a substitution or modernization is caused by an asset present in the subject property that is substandard compared to the replacement property. (B) Functional obsolescence due to a deficiency requiring an addition is caused by a component that is missing from the subject property that is present in the replacement property (C) Functional obsolescence due to a superadequacy is caused by an asset present in the subject property that is not present in the replacement property and does not contribute to value an amount equal to its cost. (d) The physically depreciated reproduction cost of the property with a deficiency or superadequacy is the cost, as of the appraisal date, to construct a new replica of that property using the same materials, design, layout, quality of workmanship and embodying the deficiencies and superadequacies of that property less the amount of physical depreciation due to physical deterioration associated with wear and tear, the impact of the elements, and aging. (e) The physically depreciated cost of the replacement property is the cost, as of the appraisal date, to construct a new property with the equivalent utility to the property with the deficiency or superadequacy using the most cost effective materials, design, and layout less the appropriate physical depreciation. (A) For curable functional obsolescence, the appropriate percent of physical depreciation for the replacement property in subsection (1)(a)(B) is equal to the percent of physical depreciation of the replacement property included in the cost to cure in subsection (1)(a)(C) and (3)(h)(A). For example, if curable functional obsolescence is cured by purchasing and installing a new machine, the replacement property is also new (zero depreciation). (See example 3) However, if curable functional obsolescence is cured by purchasing and installing a used machine that is 70% physically depreciated, the replacement property also must be 70% depreciated. (See example 4) (B) For incurable functional obsolescence, the appropriate percentage of physical depreciation for the replacement property in subsection (1)(a)(B) is the same percentage of physical depreciation as the percentage of physical depreciation of the property with a deficiency or superadequacy, as it exists in the uncured condition. (f) Functional obsolescence is incurable if the cost to cure is greater than the value of the loss. (g) Functional obsolescence is curable if the cost to cure is less than the value of the loss. (A) To be considered curable, it must be physically possible, legally permissible, and financially feasible to cure the functional obsolescence. (B) If curing functional obsolescence is required to allow the existing assets to continue to function at their highest and best use and the requirements of subsection (3)(g)(A) are met, the obsolescence is curable even if the cost to cure is greater than the value of the loss. (See Example 6) (h) The cost to cure equals the net cash out-flow anticipated to be necessary to eliminate the deficiency or superadequacy. This equals: (A) The physically depreciated replacement cost of the replacement property, plus (B) The retrofitting cost associated with installing the replacement property in the subject property, plus (C) The cost to remove the property with a deficiency or superadequacy; less (D) The salvage value of the property with a deficiency or superadequacy. (i) The excess cost to cure recognizes that installing an asset in an existing property may cost more than installing the same asset when a property is constructed new on the appraisal date. The excess cost to cure equals: (A) The retrofitting cost associated with installing the replacement property in the subject property; plus (B) The cost to remove the property with a deficiency or superadequacy; less (C) The salvage value of the property with a deficiency or superadequacy. (j) Retrofitting cost is the cost as of the appraisal date to install an asset in the subject property less the cost as of the appraisal date to install the same asset as part of new construction. (k) The value of the loss equals the present value of the after-tax loss in anticipated income from the continuing operation of the property with a deficiency or superadequacy compared to the projected operation of the replacement property. For industrial plants, this loss in income is often the result of excess operating costs due to inefficiencies in the subject plant compared to the subject property when cured of the functional obsolescence. The present value includes factors for the time period that the plant will continue to incur the loss in income and an appropriate discount rate. See OAR 150-308-0250 for the appropriate method of calculating the discount rate. (4) Examples (Assume zero external obsolescence for all examples): (a) Example 1: An example of incurable functional obsolescence due to a deficiency requiring a substitution or modernization. [Example not included, see ED. Note.] (b) Example 2. An example of incurable functional obsolescence due to a superadequacy. [Example not included, see ED. Note.] (c) Example 3: An example of curable functional obsolescence due to a deficiency requiring and addition. [Example not included, see ED. Note.] (d) Example 4: An example of curable functional obsolescence due to a deficiency requiring a substitution. [Example not included, see ED. Note.] (e) Example 5: An example of a deficiency in the subject plant that does not indicate the presence of functional obsolescence. [Example not included, see ED. Note.] (f) Example 6: An example of curable functional obsolescence due to a deficiency requiring an addition. [Example not included, see ED. Note.] [ED. 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