Methods For Valuing Personal Property
Cost ApproachActual cost (or cost adjusted for replacement cost), less ALL types of depreciation, is an appropriate valuation method. Regrettably, what has occurred is a general practice of using somewhat arbitrary physical-life depreciation schedules based on the estimated physical life of the property therefore a chair and railroad tracks both have a seven-year life. The IRS depreciation schedules are statutory for property that cannot be expensed. However, there is no basis in fact or logic to suggest that the IRS depreciation schedules are a reasonable basis for calculating value.
What Should Not be Included in CostAppraisal district instructions for rendering personal property direct the property owner to include: 1) cost freight to deliver, 2) cost of installation and 3) any special purpose building to house the equipment. This advice is not only bad; it is dead wrong. These instructions may be appropriate for IRS purposes. However, they are entirely inappropriate for determining the market value of tangible personal property. First, you can’t move, feel or touch delivery or the cost of installation. Second, and really to the point, these items are irrelevant to market value. Market value does not assume the buyer is the current owner. That is value-in-use, and no state determines taxes based on value-in-use for tangible personal property. Market value assumes the property is exposed to the market and is sold for its value. The cost of freight and installation would have no benefit to a purchaser, unless we assume the only purchaser is one who will leave the item in place.
Types of DepreciationTypes of depreciation include physical, functional and external. Physical includes wear and tear from use. Functional depreciation addresses changes in technology and what is acceptable to purchasers. External obsolescence is based on changes outside the property for real estate and not directly related to the consideration or functional worth of the property for personal property. Functional obsolescence can reduce the value of equipment by 50 or 100% depending on the type of change. Changes in market conditions can impact the value of inventory or equipment held by industries in decline. For example, imagine a deserted army base in the middle of a desert 100 miles from the nearest town and with poor quality roads between the army base and the town. Even if the buildings are in good condition and do not have function or physical depreciation, external obsolescence could be 100 percent if there are no users or demand.
External Obsolescence (aka Economic Obsolescence)External obsolescence negatively impacts the value of drilling rigs and oil field equipment during downturns in the oil industry. The price of oil fell from over $100 in mid-2014 to about $50 in early 2017. The U.S. rig count fell from around 1,600 in September 2014 to a low of 325 and has now rebounded to 688 rigs, or forty-three percent of the level from three years ago. This is not the time for a detailed discussion of the valuation of a $1.2 billion drilling rig for offshore drilling. However, we will soon see how an offshore drilling company is valued at 25% of book value based on its stock price. The only difference being the valuation approach. We do know there is limited appetite for such offshore exploration until the largest multinationals are confident the price of oil will stabilize at a level that is about 50% higher than the current level. Further, the cost to dry-dock and protect the value of such a rig not in service offshore is material.
Income ApproachThe income approach is used to value leased property. The valuation may really be more of a leased fee valuation, subject to the value of the credit of the lessee. The income approach simply considers the quantity and quality of the income stream that an asset is expected to deliver. For example, if the drilling rig was leased to a company that then had a AA or AAA rating from the large rating companies, such as, Moody’s, S&P or Fitch, it would be possible to value the leased fee (including the lease) by comparing it to similar term corporate bonds with a similar rating, many of which may not have specific collateral. In addition, for a fee simple value the relevant rental rate is the rate for used equipment and not for brand new equipment featuring the latest technology.
Example – Value of Drilling Rigs when Oil Prices are LowTo illustrate, imagine an investment bank raised debt from this AA or better rated company to purchase 5 drilling rigs with a total cost of $5 billion. These are rigs suitable for offshore development in most parts of the world. The rigs were purchased and financed in September 2014 when the price of oil was $110 per barrel. Now fast forward to January 1, 2016 and the price of oil is about $30 per barrel and January 1, 2017 and the price of oil is about $55 per barrel. Consider the following questions:
- What is the value of the rigs if the lessee (a drilling company) is still paying on the leases but has been downgraded to junk by the rating agencies and has mothballed the rigs since they are not able to lease them?
- What is the value if the tenant files bankruptcy and stops making payments?
- How do you estimate market rent and utilization rates when demand is low or non-existent? It is difficult to determine market rent when there are few transactions.
- Should the lessee’s credit be considered in valuing the property? The lease is a contract and is clearly intangible personal property.
- Excluding the intangible value of credit-enhanced leases and of intangible property on the rig is essential to determining the value of the tangible personal property.
Sales Comparison ApproachThe sales comparison approach for real estate is based upon the hypothesis that it is possible to generate a credible opinion of value based upon reviewing the sales price of similar properties and making adjustments for the differences from the subject property.
Real Estate AppraisalSingle-family appraisers can select similar properties in homogeneous neighborhoods requiring minimal adjustments and quickly develop a credible opinion of value. The hypothesis works well for houses since the Multiple Listing Service (MLS) has seventy-five to 200 fields of data for each sale, as well as information immediately available on houses under contract and for sale. This data brings transparency to valuing houses in homogeneous subdivisions The sales comparison approach works well for commercial real estate such as apartments, office, retail and warehouse. However, the quality of available data is modest.
Personal Property Sales DataSales data is difficult to obtain for personal property and sales data is similarly difficulty to find for commercial real estate. Sales data is readily available for some types of personal property including vehicles, boats and aircraft. There are sites with information on personal property available for sale. However, the asking price can be much higher than the sales price or market value. Further, it is important to review the level of trade (retail or wholesale). The sales comparison approach for personal property is challenging due to the private nature of personal property sales (they typically are not publicly available) and the content of sales of groups of property are not homogeneous. Hence, it is difficult to compare the sale of one group of assets to the sale of another group of assets. Individual asset sales can be tabulated at auctions based on details with asset age, type and condition. This process can be expected to generate an annual depreciation schedule that includes physical, functional and external obsolescence for a type of asset in a geographic area. Sales prices for individual assets are indications of the market value at the retail level of trade and need to be adjusted to the wholesale level of trade. But the retail values do indicate a ceiling for value. The discount for the wholesale level of trade could be too large to make the retail sales data meaningful. It may be possible to find recent comparable sales of very similar property. However, as a substitute, given the paucity of data available regarding personal property sales and the poor quality of the data with regard to condition, level of usage and whether or not recommended maintenance was performed, developing a schedule of values relative to acquisition cost is a reasonable and cost efficient method of estimating the value of personal property. There needs to be two additional tables depending on the purpose of the appraisal: 1) to separate tangible and intangible property and 2) to extract any freight, setup costs and specialized buildings built to house equipment. Depending on the case, it may not be practical to build a table to extract freight, setup costs and specialized buildings.
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