Economic obsolescence

[Tim Hicks (Texas)]

Economic obsolescence not external obsolescence.

I doubt that any appraiser here can answer the question even remotely adequately but every appraiser should be able to account for the difference in the indicated values between their cost and market approaches due to the collapse of the housing market.

Prove me wrong! Take the challenge!

Funny, but the market around here was not effected as much as some of the other falsely inflated markets in the country. A proper Marshall and Swift Cost Approach rarely needs any economic adjustment in my area. We didn't have drastic increases in pricing, so we didn't have drastic drops in most areas.

However, the cost approach is the cost approach and the actual sales should relatively give you an actual idea what the economic adjustment should be for each individual market.

 

[CANative]

She should just calculate the EO using discounted cash flow analysis.

 

[SANDY]

I would bet that few if any reviewers, underwriters, appraisers' boards, appraisers or anyone else that ever looks at appraisals would catch that the external obsolescence box is checked "no" when it exists in nearly every market across the country for the last few years.

 

[SANDY]

Funny, but the market around here was not effected as much as some of the other falsely inflated markets in the country. A proper Marshall and Swift Cost Approach rarely needs any economic adjustment in my area. We didn't have drastic increases in pricing, so we didn't have drastic drops in most areas.

However, the cost approach is the cost approach and the actual sales should relatively give you an actual idea what the economic adjustment should be for each individual market.

Lucky you! Just like the actual sales should give you an actual idea what the site value should be for each individual market if all the other data is accurate-right?

The only reason appraisal methodology has adopted the inference method for estimating EO is that it correctly states that calculating it is typically highly subjective and is difficult to isolate market data that is attributable to it alone.
I think it was Mike Kennedy that posted what I believe is the best method for estimating EO. It was one of his infamous link posts.

 

[SANDY]

Any approach performed must be credible. Can't or don't now how to figure out site value, well then you better not do a cost approach. If the client insists then you must turn down the assignment. Can't figure out how to calculate depreciation and/or obsolescence. Same answer.

As for making that adjustment within the cost approach section, some may agree and others will disagree but generally I do not make the adjustment, with an explanation within my reconciliation that the cost approach was given no value due to the presence of economic obsolescence. If somone wants to take me to task on it, fine. My argument is I've already stated it's not a reliable source in determining the opinion of market value for the subject due to the economic obsolescence. What, someone is going to argue it is?

Try building the same house and sell it for what it cost to build. If it were possible, build the same house "depreciated" out and see if you can sell it for cost. Making the adjustment or not making the adjustment, it can't be done unless the builder loves losing cash.

Thank you for posts. You offer the most reasonable and practical solution to the problem.

 

[Michigan CG]

I don't plug in numbers into my cost approach to make them line up with my SCA. And as a result, economic obsolescence is fairly easy to determine. Couldn't care less if my cost approach without a economic (external) obsolescence adjustment comes out 10,000's of thousands if not $100,000+ higher. Just like I didn't care when my cost approach was $10,000's lower then my sales comparison approach during the boom.

Then you are not doing the approach correctly. Every part of an appraisal should be credible.

Explain to me further how doing a bunch of cost approaches is going to provide you with a numeric indication of economic obsolescence......

You do cost approaches on sales. Appraisal 101.

......In order for that method to be reliable at all you would have to have done numerous appraisals (with a sca for comparison to cost) in the same neighborhood and of similar homes and within a stable market in order to account for neighborhood and time variables. ...

No you wouldn't. I would suggest reading some books so you will understand it correctly.

..... I would bet you that most appraisers don't do a bunch of cost approaches and compare them to the sca for similar properties.....

They don't because that would be the wrong way to do it.

 

[Scott R Marshall]

Then you are not doing the approach correctly. Every part of an appraisal should be credible.

Not going to argue. In theory I 100% agree with you.

 

[Tim Hicks (Texas)]

Lucky you! Just like the actual sales should give you an actual idea what the site value should be for each individual market if all the other data is accurate-right?

The only reason appraisal methodology has adopted the inference method for estimating EO is that it correctly states that calculating it is typically highly subjective and is difficult to isolate market data that is attributable to it alone.
I think it was Mike Kennedy that posted what I believe is the best method for estimating EO. It was one of his infamous link posts.

You are incorrectly thinking that the cost approach is not reliable. There are times when I will do the cost approach to value first to determine a reasonable value when appraising secluded, rural properties or odd ball properties. You don't ever have land sales to base site value? I am amazed at how much the cost approach is "faked" in this market area and how few appraisers actually check for land sales that don't support the site value they pulled out of the air. If you are in a saturated market with numerous sales and no recent land sales, it is not that difficult to determine a site value by doing a proper cost approach. Sometimes the EO is actually the drop in site values. The cost to build rarely goes down. Why would they still be building if it did? Builders would not be building if they could not make a profit. If you have actually been taught to do a correct cost approach it is not that difficult to figure EO comparing actual sales to the cost approach.

 

[SANDY]

You are incorrectly thinking that the cost approach is not reliable. There are times when I will do the cost approach to value first to determine a reasonable value when appraising secluded, rural properties or odd ball properties. You don't ever have land sales to base site value? I am amazed at how much the cost approach is "faked" in this market area and how few appraisers actually check for land sales that don't support the site value they pulled out of the air. If you are in a saturated market with numerous sales and no recent land sales, it is not that difficult to determine a site value by doing a proper cost approach. Sometimes the EO is actually the drop in site values. The cost to build rarely goes down. Why would they still be building if it did? Builders would not be building if they could not make a profit. If you have actually been taught to do a correct cost approach it is not that difficult to figure EO comparing actual sales to the cost approach.

If you have a saturated(over supply due to economic conditions) market-there is likely to be EO present- correct? And if at the same time, you have no recent land sales to determine site values it makes it difficult to accurately apply allocation or extraction-no?

In order to calculate EO one must have a good market based site value and to calculate site value one must have a good market based EO calculation-No?

 

[SANDY]

In my opinion, this problem illustrates that sometimes there are big differences between what appraisal principles(theory) require and what is actually happening in application of those principles.

Appraisal practice would dictate that where EO is present it should be calculated(at a minimum by the standard inference method) and quantified in the CA method and the EO box should be checked yes with a proper explanation to the intended user/client regarding a definition of EO, its method of calculation and reliability.

However, it appears that at least some appraisers are utilizing different ways to deal with this issue. Some are letting the CA be what it is--way higher than SCA with an EO calculation left out and caveat CA addendum language stating that the CA is not being relied upon anyway. Others (I think very few) are including it in their CA and hopefully defining what it means and how they calculated it by inference. Even fewer are checking the EO box yes.

Point is- think out what "you" are doing and make sure you have proper disclosures and defense language in place.

It might help if you look at your comparables used and not used sales prices during the height of the market and compare their sales prices now on a sp/sf basis factor out site value (might even want to factor out physical dep. for the difference in time) and see what falls in your lap.

Have a nice day!