11.2 Breakdown and Market Extraction Methods

Two More Ways to Measure Accrued Depreciation

Chapter 11.1 used life fractions. ECO V.f also requires:

• Breakdown method — build depreciation from parts (physical, functional, external).
• Market extraction — read total depreciation from what buyers paid for improved properties relative to cost and land.

Both answer the same cost-approach need: How much of cost new is gone as of the effective date? They differ in data and granularity.

Breakdown Method — Structure

Breakdown (also called the observed condition or component method in some texts) estimates accrued depreciation by separately measuring:

1. Physical deterioration — curable and incurable
2. Functional obsolescence — curable and incurable (deficiency or superadequacy)
3. External obsolescence — typically incurable (locational or economic)

Total depreciation = Σ all measured components (avoid double-counting the same loss in two categories).

Exam labels: External is also called economic or locational obsolescence in many stems. Physical “curable” ≈ deferred maintenance / short-lived items where cost to cure ≤ value added.

Physical deterioration in breakdown

Curable physical: Cost to cure (paint, flooring, roof if economically justified, missing appliances that are real property fixtures in the assignment, etc.).

Incurable physical: Often estimated by age-life on long-lived components after removing curable items—or by residual physical after other methods. Example: structural wear measured as (EA ÷ TEL) × cost of long-lived items.

Functional obsolescence in breakdown

Common measures (recognition + arithmetic):

• Curable functional (deficiency): Cost to cure if cure is feasible (add a bath if value added ≥ cost).

• Incurable functional (deficiency): Depreciation = cost of the deficiency if installed when new is not the full story; exam classics use depreciated cost of the missing item or capitalized rent loss / value loss net of cost if cured, depending on stem. A frequent teaching form for incurable deficiency:

  FO = Cost of correction if installed new − Physical depreciation already charged on that item
  or loss in value from market/income evidence when provided.

• Superadequacy: Cost of the excess feature (as of cost new) less physical depreciation on it, minus any minor value contribution—if the market gives no value to a residential gold-plated elevator, most of that cost is functional obsolescence.

Follow the stem’s formula when numbers are supplied; do not invent a complex FO model when the question only asks you to classify the loss.

External obsolescence in breakdown

Often:

EO = Capitalized rent loss (residential: GRM × monthly rent loss; income property: rent loss ÷ cap rate),
or a lump-sum market penalty from paired sales,
or a percentage of improvement cost (or of total value) when the stem gives the rate.

Allocate EO between land and building if required: external influences often hit both, but many residential exam items apply the improvement-related portion only in the cost approach depreciation total.

Worked Breakdown Problems

Worked problem 1 — Full breakdown stack

Subject improvements RCN: $400,000
Land: $100,000

Depreciated improvements = $400,000 − $152,000 = $248,000
Cost approach = $100,000 + $248,000 = $348,000

Classification drill: Landfill stigma is external, not functional. Bad floor plan is functional, not physical. Peeling paint is physical curable.

Worked problem 2 — External via rent loss

Facts: Comparable rent without external issue: $2,000/month. Subject near busy highway: $1,850/month. Monthly rent loss = $150. Residential GRM = 150. Loss attributed entirely to improvements for this stem.

External obsolescence = $150 × 150 = $22,500

If RCN $300,000; physical depreciation $60,000; no functional; land $90,000:

Total dep = $60,000 + $22,500 = $82,500
Depreciated improvements = $217,500
Cost approach = $307,500

Worked problem 3 — Avoid double counting

If age-life on the whole building already embeds “old kitchen,” do not also subtract a full functional kitchen penalty without adjusting. Breakdown requires mutually exclusive slices. Exam stems that give a clean table of separate amounts expect you to add them once.

Market Extraction Method

Logic

Buyers of improved properties pay a total price. If you can support land value for that sale and cost new of its improvements as of the sale date, the market’s remaining payment for improvements is:

Contributory value of improvements = Sale price − Land value

Compared to cost new:

Total depreciation (extracted) = Cost new − (Sale price − Land value)
Total depreciation = Cost new − Contributory improvement value

Depreciation percent = Total depreciation ÷ Cost new

That percent (or dollar pattern) can be applied to a similar subject’s cost new when ages, quality, and market conditions align—or used as a reasonableness check on age-life/breakdown.

Worked problem 4 — Classic extraction of depreciation

Comparable sale price: $480,000
Land value of comparable (supported): $120,000
RCN of comparable improvements (sale date): $450,000

1. Improvement contribution = $480,000 − $120,000 = $360,000
2. Total depreciation = $450,000 − $360,000 = $90,000
3. Depreciation % = $90,000 ÷ $450,000 = 20%

If the subject has RCN $500,000 and is truly comparable in age/condition/market segment, extracted depreciation indication ≈ 0.20 × $500,000 = $100,000 (then add subject land separately).

Worked problem 5 — Multiple sales, reconcile percent

Reconcile near 20–21% total depreciation for similar 15–20 year homes. Subject RCN $400,000 → depreciation ≈ $80,000–$84,000.

Worked problem 6 — Extraction reveals more than age-life

Subject/comp twins: EA 20, TEL 50 → age-life suggests 40% depreciation.
Sale: Price $500,000; land $150,000; RCN $400,000.

Improvement contribution = $350,000
Extracted depreciation = $400,000 − $350,000 = $50,000 = 12.5%

Market shows less depreciation than crude age-life—perhaps strong location, updates not reflected in “20 effective age,” or RCN/land mismatch. On the exam, if asked what market extraction indicates, answer 12.5% / $50,000, not the theoretical 40%. If asked which method is more market-based here, extraction wins when data are good.

Worked problem 7 — Algebra variants

Sometimes stems give sale price, depreciated improvement cost, and ask for land (extraction of land—Chapter 7). Here the unknown is depreciation:

Given: Sale $600,000; land $180,000; RCN $500,000.
Depreciation = $500,000 − ($600,000 − $180,000) = $500,000 − $420,000 = $80,000.

Given: Sale $600,000; land $180,000; depreciation $80,000.
RCN = improvement contribution + depreciation = $420,000 + $80,000 = $500,000.

When Each Method Is Preferred

Important: Market extraction usually gives total depreciation; it does not automatically split physical vs functional vs external unless you do further analysis. Breakdown explains the total; extraction observes the total.

Step Checklists

Breakdown checklist

1. Estimate cost new (correct cost type and components).
2. Measure curable physical (cost to cure).
3. Measure incurable physical (often age-life on long-lived base).
4. Measure functional losses (curable/incurable; deficiency/superadequacy).
5. Measure external losses (rent loss, paired sales, given %).
6. Sum without double-counting.
7. Subtract total from cost new; add land.

Market extraction checklist

1. Select improved sales similar to subject (or adjustable).
2. Estimate land value for each sale as of sale date.
3. Estimate cost new of sale improvements as of sale date.
4. Improvement contribution = Price − Land.
5. Depreciation $ = RCN − Improvement contribution.
6. Convert to % of RCN; reconcile across sales.
7. Apply to subject RCN; add subject land.

Common Exam Traps

• Calling neighborhood decline functional obsolescence (it is external).
• Calling a bad floor plan external (it is functional).
• Extracting depreciation as Price − RCN and forgetting to remove land first.
• Using subject land with a comparable’s price without analyzing the sale’s own land.
• Treating extracted total depreciation as only physical when FO/EO are present (total includes all causes the market priced).
• Adding breakdown components that overlap the same roof or kitchen twice.
• Applying a depreciation % from luxury sales to a starter-home subject without comparability.

Numeric Drill

E1. Sale $550,000; land $150,000; RCN $480,000. Depreciation $? %?
→ Contribution $400,000; dep $80,000; 16.7%.

E2. Physical curable $10,000; physical incurable $70,000; functional $15,000; external $30,000. Total dep?
→ $125,000.

E3. Monthly rent loss $200; GRM 140; all improvement-related EO. EO $?
→ $28,000.

Bridge to Cost Approach Reconciliation

You now have three depreciation engines: age-life, breakdown, and market extraction. The final cost-approach step is not another depreciation formula—it is reconciliation: combining land + depreciated improvements into an indicated value and judging when that indication deserves heavy weight versus when sales comparison or income should dominate.