Equipment Appraisal Blog | Understanding Machinery Appraisals

For machinery & equipment (M&E) appraisers, there are basically two approaches to value that are ultimately relied upon when completing valuations: the Sales Comparison Approach and the Cost Approach.

Here is a brief description of each:

The Sales Comparison Approach

The Sales Comparison Approach indicates value by analyzing recent sales (or offering prices) of properties that are similar (i.e., comparable) to the subject property. If the comparable data is not identical to the properties being appraised, the selling prices of the comparable items are adjusted to equate them to the characteristics of the properties being appraised.

The reliability of this technique is dependent upon the degree of comparability of each property with the property under appraisal; the time of the sale; the verification of the sale data; and the absence of unusual conditions affecting the sale. This approach focuses on the actions of actual buyers and sellers.

The Cost Approach

The logic behind the Cost Approach is the Principle of Substitution: a prudent buyer will not pay more for a property than the cost of acquiring a substitute property of an equivalent utility.

Using the Cost Approach, the appraiser starts with the current Replacement Cost New of the property being appraised and then deducts for the loss in value caused by physical deterioration, functional obsolescence, and economic obsolescence.

The third approach to value, the Income Approach, is rarely used for M&E appraisals, and I will leave that discussion for another time. The Sales Comparison Approach is also commonly referred to as the “Market Approach”, however, don’t let that trick you into thinking the only time you rely on market data is under this approach. To effectively use the Cost Approach, an appraiser should rely on the marketplace as well, to estimate the variables involved with this approach, including replacement cost new, useful life, depreciation, and salvage value.

Perspective From Both Approaches

Every appraiser has their own process as to how they ultimately utilize the tools available to determine value. It is ultimately an independent, unbiased, subjective opinion, based on the gathering of a reasonable amount of data, which is developed during a research and analysis process.

To that end, from my experience, I have found it beneficial to take components from both approaches, established directly from the marketplace, and create a dual perspective that ultimately forms credibility checks to both, and provides the appraiser with supportable conclusions. Given that comparable sales data can tend to be inconsistent from machine to machine, even from the same sources, this blended approach can create a way to make sense of all the data points and better understand how particular assets should depreciate in the marketplace under normal maintenance and wear and tear guidelines. The use of the Cost Approach in any other way, such as using straight-line depreciation to cover all forms, or trying to develop credible levels of replacement cost and obsolescence by using broad industry data, is simply not reliable or supportable.

In summary, regardless of how much weight an equipment appraiser places on either of these two approaches during a valuation analysis, they should assure their clients that the data collected comes directly from the marketplace. The independent sources that an accredited M&E appraiser can find for virtually any type of asset are out there and available, they just need to do a bit of digging to find them

Many appraisers, buyers, and sellers involved in the aircraft industry consider the valuation of these assets unique in comparison to the rest of the equipment markets, with many businesses only willing to engage “experts” in this industry to complete the appraisal work. While it is true that the aircraft marketplace has a plethora of companies solely dedicated to working in this industry alone, when it comes to valuation, the methodologies, approaches, and data required to perform effective appraisals are very similar to the rest of the machinery & equipment markets. In fact, the very “uniqueness” in which this industry is viewed, opens the door to any number of independent sources and data points in which to gather the information required to complete a solid valuation.

Specific to aircraft appraisal, it is very common, and generally required, that for any sale, leasing, bank financing, or similar transaction, there be made available from the aircraft owner or broker, a detailed “spec sheet” that provides important data including the airframe time and landings, engine make, model, hours and cycles, avionics, interior specs, maintenance programs, ownership history, recent refurbishments, and related information. This document is above and beyond what an appraiser expects to collect during a valuation for most other types of machinery & equipment and encompasses the key parameters in developing your valuation.

Additional benefits when performing aircraft appraisals include the ability to find any number of third-party sources familiar with the industry, specific market, and make/model aircraft you’re researching, that will openly discuss and provide their opinions on. There are databases available to provide historical sales and estimated values on most types of aircraft that are built on quality information, developed over decades, by industry experts. You can also find plenty of articles written about important topics such as annual operating costs, historical fluctuations in markets, future trends based on technology advances, and any number of related areas.

In many ways, because of the constant global focus and overall significance of the aircraft industry, the amount of data available to consider when completing an appraisal is more abundant than in many other markets. An experienced, accredited equipment appraiser has all the tools available to complete a reliable, supportable aircraft valuation.

While being an “expert” in any one industry can have its advantages, the methodologies and approaches of completing an appraisal assignment are consistent across every business sector. The key components involve the collection and review of data, both specific to the asset you’re valuing, and from a reasonable number of external sources within the marketplace itself, to make the appropriate comparisons and adjustments. In all of these ways, the aircraft industry is essentially one of the most complete markets to perform appraisals in.

In our last post, we discussed the most commonly used value definitions specific to bank financing and equipment leasing. In this installment, we are focusing on internal reasons for obtaining an appraisal, such as accounting, tax, and insurance compliance requirements.

Depending on the industry you work within, certain machinery & equipment can be large and complex, involving significant investments outside of the pure “hard cost” of the assets. These expenses include shipping, construction, installation, custom build-outs, and operator training, simply to get the equipment up and running.

For these reasons, the American Society of Appraisers (ASA) developed a definition of value to consider these costs as part of the overall capitalized value of the machinery. This expanded definition is called Fair Market Value-Installed and is similar to Fair Market Value with certain considerations added.

Here are the two definitions side by side, for comparison:

Fair Market Value (FMV)

Fair Market Value is an opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.

Fair Market Value-Installed

Fair Market Value-Installed is an opinion, expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, independent of earnings generated by the business in which the property is or will be installed, as of a specific date.

The highlighted words in the expanded definition are what allows the appraiser to include expenses, commonly referred to as “soft costs”, as a complement to the actual purchase price of the equipment. These additional investments will add value as part of the overall asset, as long as it remains installed, which is a consideration when valuing for any internal business purpose specific to your company.

Most machinery-intensive industrial manufacturing facilities and large process production plants will see these types of costs associated with their equipment. The requirements necessary to ship large assets, often overseas, add extra foundations to safely install the equipment on the facility floor, the electrical, plumbing, and process piping needed to work with the equipment, and paying the manufacturer representatives for weeks of on-site training, are some of these costs that can be capitalized as part of the overall value of the assets.

Not every business has equipment with high installation costs associated with it, but if yours does, don’t forget to consider these additional investments as part of the overall value when working on internal compliance projects related to accounting, tax, and insurance.

In a recent blog post in early May, we talked about the many reasons a company will need to obtain an updated equipment appraisal to get the most out of a business goal or requirement. One of the primary issues we discussed pertained to traditional bank financing and equipment leasing.

The next step in understanding how these appraisals can work best for your business, we will need to see through the eyes of your bank and leasing company as they determine the right level of value to consider when making investment decisions.

Here are the most commonly utilized values and their American Society of Appraisers (ASA) definitions.

Fair Market Value (FMV)

Fair Market Value is an opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.

Orderly Liquidation Value (OLV)

Orderly Liquidation Value is an opinion of the gross amount, expressed in terms of money, that typically could be realized from a liquidation sale, given a reasonable period of time to find a purchaser (or purchasers), with the seller being compelled to sell on an as-is, where-is basis, as of a specific date.

Forced Liquidation Value (FLV)

Forced Liquidation Value is an opinion of the gross amount, expressed in terms of money, that typically could be realized from a properly advertised and conducted public auction, with the seller being compelled to sell with a sense of immediacy on an as-is, where-is basis, as of a specific date.

When any type of financing or leasing is involved, these parties may independently determine which value they would prefer to weigh, and in many cases, they look at all three. Every private and government-owned (ex.: SBA) financial institution has its own internal policies to abide by. What we most commonly see when appraisals pertain to bank financing is that Orderly Liquidation Value tends to be the primary focus. A lot of banks also have percentage tables they are willing to lend from, such as 70% of Fair Market Value or 80% of Orderly Liquidation, for example.

Equipment leasing companies may take a slightly more aggressive stance on valuing machinery & equipment as they are technically the owners of the assets and may have more extensive experience and knowledge in certain industries. A “sale-leaseback” is a common term where the business purchases your assets and leases them back to you under a monthly rental payment plan. This sale may be completed at Fair Market Value and, to offset their potential investment risk, they might collect a security deposit or similar resource as “additional collateral” in the transaction. Any sale back to the business at the end of the lease term is almost always at Fair Market Value.

In any of these cases, I would suggest having the appraiser estimate both FMV & OLV and try to avoid FLV, as this value is akin to an auction, which is at a lower value level, and doesn’t pertain to an ongoing business where your machinery & equipment is hard at work. And as always, ensure the appraiser you hire is accredited by the ASA.

Image source: FNQ at en.wikipedia license

When you are considering buying, selling, investing in, or financing machinery & equipment, the age of the assets will play an important role in determining the fair market value and ultimately, the price you are willing to pay or accept for it.

Useful Life

The useful life of equipment is generally considered just a guideline that estimates when the asset would need to either retire from service or need refurbishing and reinvestment to prolong its life. Many factors can affect this estimate such as usage, maintenance, technology, and overall manufacturing quality.

Chronological Age

The chronological age of machinery & equipment is simply calculated from the date of its original manufacturing to the effective date you are considering, usually a current date. So, as an example, if a used Caterpillar excavator was originally built in 2011 and you want to purchase it today, the chronological age of that asset would be 10 years.

Effective Age

Using that same example, over the 10 year period from 2011-2021, the specific Caterpillar excavator you’re looking to purchase, sell or finance, will have a certain number of hours logged, will have a specific prior sales history (1 owner or multiple), been under a good or not so good maintenance program each year and possibly had certain major components replaced over that time.

All of these factors will play a part in considering an adjustment to the chronological age which would create a more realistic effective age.

If the excavator was only used 1,000 hours per year, that might be construed as half or even less than normal usage, while being maintained on a daily basis. On the flip side, if the machine had over 20,000 hours on it with no component replacements over the 10 year period, you would take a hard look at what would need to be invested into it to bring the machine into good operating condition and extend its life.

In many industries, you will see certain types of equipment originally manufactured decades ago while still in good operating condition. These machines have likely not been affected by changes in technology and have been well maintained with component parts replaced as needed over their lifetime.

There are also plenty of examples of machinery in heavy usage environments such as mining and aggregate, that well exceed normal operating hours which could have an adverse effect on value. However, as long as these machines are well maintained with components replaced as needed, these assets are durably built and designed to last a long time.

In summary, effective age is an important component to understanding machinery & equipment value. While it is a subjective estimate based on a number of variables, it provides a working guideline to appraising and ultimately understanding what you should be buying and selling these assets for at any given time.