By: Mark Lansing
If you own property that is valued by the cost approach by assessors or appraisers, you likely found out that the only obsolescence being deducted was physical depreciation. Yet, it is fundamental that to reach market value by the cost approach, the assessor must also consider and deduct for both functional and economic obsolescence. Like Functional Obsolescence, to obtain economic obsolescence, you often must apply for it with the assessor/appraiser. Economic obsolescence arises from conditions that exist outside of the property. For example, a modern coal plant has a heat rate of 8500. At one point, the coal plant was considered more economical to produce electricity than a natural gas combined cycle gas turbine plant (even though, the combined cycle plant had a much lower and, thereby, more efficient, heat rate of 6500). However, when natural gas prices crashed, starting in the latter part of 2008, it became competitive with coal prices (and have remained at or near coal prices). The coal plant’s competitive advantage evaporated. The obsolescence at coal plants resulted from the market forces of fuel pricing, negatively impacting the coal plant’s gross margin (or dark spread). As the dark spread for a plant contracts, it becomes less profitable, and the coal plant’s value declines. To capture this reduced value in the marketplace by the cost approach, the assessor/appraiser must quantify the economic obsolescence applicable to the coal plant. Of course, the computation of obsolescence increased as a coal plant’s heat rate increased.
Although this economic obsolescence was substantial, a review of most assessments (even taking into account “special factors” applied by assessor/appraiser) failed to accurately quantify its impact on value in coal plants. The result has been the significant over statement of value of coal plants on assessment rolls. This issue is not limited to electric generation plants. It has been found in breweries, steel production facilities, older manufacturing centers, older warehouse and distribution centers, and older hospitality units (e.g., franchise required changes may preclude “re-franchising” of older facilities, increasing probability of non-renewal and, thereby, reduced rates per room after the franchise agreement is not renewed).
Both functional and economic obsolescence can also be quantified through an analysis of market sales of property. By comparing sales of obsolete facilities with non-obsolete facilities, the appraiser can capture the obsolescence in the older facilities.
Bottom line, if the taxpayer does not identify and quantify the economic obsolescence, its property will continue to be over valued by the assessor/appraiser.
If you have any questions, please contact Mark Lansing in our Washington D.C. office at (202) 466-5964.