Functional Or External Obsolescence

[Lucidity]

When a site is under improved what differentiates whether it suffers functional or external obsolescence? What is the distinguishing factor?


This a pop quiz! I have formed an opinion on this but am exasperated at how many of my fellow professionals quickly credit this to functional with out further thought to when it should be credited to external.

The details of my specific situation and the details are as follows:

A townhouse six-plex is constructed in an agricultural area a good four miles from any major thoroughfares. It's located in a cluster of other identical buildings developed at the same time and are all identical. After development the owner splits up the development into individual parcels for each building. This development is located on a collector route that serves most of the traffic in and out of the northeast side of the county. We will call this Road A.

The property I'm talking about it at the far west side of the development cluster and fronting on Road A.

Five years after development of these multifamily property planning begins for an interstate to connect to the larger city in the next county, which was previously isolated due to a river at the county borders. Approximately ten years after development of the multifamily property the interstate is developed and opens, with the entrance ramp approximately 100 yards west of the subject off of Road A. Then over the next ten years this new interchange is developed with a variety of commercial properties, typical for interchange traffic. Two C stores, specialty retail, banks fast food, ect. The subject site is poised to be the next best site for redevelopment and reflects a higher and better use of retail, with resulting higher land value relative to multifamily sites. It is still developed with the multi family property that cash flows as such, with sufficient income to cover current potential land rent plus some. Assuming the six plex is an interim use and holds some contributory value over the land as if vacant what type of obsolescence does this describe?

 

[hastalavista]

Based on your description, I'd say it was external... but here is what I hang my hat on:

If the improvements were constructed and the H&BU was multifamily at that time, then there is no functional obsolescence (except if market requirements have changed for the type of multifamily improvement).
After the improvements were built, an external condition changed; that external condition results in external obsolescence.

Now, if the improvements, when they were built, were not the H&BU, then the subject would have some functional obsolescence (and might still have external).

The remaining economic life of your subject may be much shorter than its remaining useful life.

 

[Pittsburgh Pete]

And to put things more simply (I'm a simple guy), it would appear what has changed is the "externalities" of the property with development patterns changing. Sounds like the ultimate change impacting the property is "external" to the property. I'd vote for external obs.

 

[Gobears81]

There was a thread not that long ago about functional vs economic obsolescence on a house that was super-adequate, and some of the issues raised are not entirely different than what the issue is here. There were good arguments on both sides, and it might be worth checking out if you are interested.

I hate to exasperate , but have to go functional, though I am filling in the blanks...most importantly that it is feasible to construct a sixplex in the market. If it is in fact feasible, the site is now super-adequate for the use, which is a functional issue. I brought up this example in the aforementioned thread, but did an appraisal of a proposed professional office building about 8-years ago or so and it was marginally feasible in this market, but my value was quite a bit below the project costs. Why? Because it was on a signalized intersection where the highest and best use, as vacant, is retail. The super-adequate site did not result in much of an increase in the value, so it was squarely the wrong use for the site, which is a functional issue. Take the same building to a nearby office park and the value would have been relatively consistent with the project costs.

Based on your description, I'd say it was external... but here is what I hang my hat on:

If the improvements were constructed and the H&BU was multifamily at that time, then there is no functional obsolescence (except if market requirements have changed for the type of multifamily improvement).
After the improvements were built, an external condition changed; that external condition results in external obsolescence.

Now, if the improvements, when they were built, were not the H&BU, then the subject would have some functional obsolescence (and might still have external).

The remaining economic life of your subject may be much shorter than its remaining useful life.

The issues that took place at the time of construction aren't completely relevant in the context of whether obsolescence is functional or economic, as of the (current) effective date.

 

[Lucidity]

(except if market requirements have changed for the type of multifamily improvement).

Now, if the improvements, when they were built, were not the H&BU, then the subject would have some functional obsolescence (and might still have external).

Your answer is in line with what I was thinking as well. Every indication suggest the improvements were the highest and best use for the site at the time it was constructed. The improvements were cookie cutter townhouse rental units then with little to no frills and remain basic in functional design and for what is demanded in this market now.

 

[Pittsburgh Pete]

I hate to exasperate , but have to go functional, though I am filling in the blanks...most importantly that it is feasible to construct a sixplex in the market. If it is in fact feasible, the site is now super-adequate for the use, which is a functional issue. I brought up this example in the aforementioned thread, but did an appraisal of a proposed professional office building about 8-years ago or so and it was marginally feasible in this market, but my value was quite a bit below the project costs. Why? Because it was on a signalized intersection where the highest and best use, as vacant, is retail. The super-adequate site did not result in much of an increase in the value, so it was squarely the wrong use for the site, which is a functional issue. Take the same building to a nearby office park and the value would have been relatively consistent with the project costs.

And why is it superadequate? Because of developments in the surrounding market which are "external" to the property.

We disagree.

 

[hastalavista]

The issues that took place at the time of construction aren't completely relevant in the context of whether obsolescence is functional or economic, as of the (current) effective date.

I couldn't disagree with you any more on this.

 

[NachoPerito]

The market conditions at the time of development make this example external obsolescence.

But, if I was doing this appraisal today would I do a lot of research to determine this very specific fact? Probably not because whether it is functional or external, the important thing is to recognize that there is obsolescence.

 

[hastalavista]

The market conditions at the time of development make this example external obsolescence.

But, if I was doing this appraisal today would I do a lot of research to determine this very specific fact? Probably not because whether it is functional or external, the important thing is to recognize that there is obsolescence.

I agree in part.
However, if adjustments are warranted in, say, the SCA due to the obsolescence, then its identification would be necessary to ensure it is accounted for in the correct element of comparison.
Now, I also acknowledge that the above is a very technical issue and in the real world, if I identify the obsolescence as A rather than B, how often will that materially impact the results? Likely not often, but correct is correct, be it a technicality or not.

 

[Gobears81]

And why is it superadequate? Because of developments in the surrounding market which are "external" to the property.

We disagree.

I admitted in the aforementioned prior thread that this wasn't as clear of a case for functional obsolescence as many of those who were arguing for it, so I acknowledge this to be the case here, as well. Though, AI is teaching functional obsolescence for this very issue.

I couldn't disagree with you any more on this.

Why? Take an opposite situation than what this case sounds like and say that someone made a bad decision of constructing something several years ago, yet for whatever reason, something has changed which results in this somehow becoming an ideal improvement on the site. In that example, what does it matter that it was a bad decision before? Should we allow that to change how we analyze the property with a current effective date? My point is that we analyze the property today, rather than five years ago. Whether it was feasible or not at the time of development is irrelevant-what is relevant is whether it is feasible to build today. If it isn't feasible as of today, is it a site-specific issue or a market specific issue? Based on the information provided, it sounds like a site-specific issue, due to being on Primo Road A. But if you move one site over to the interior street where land values are lower and it becomes feasible, then you have a functional obsolescence scenario