External Depreciation Adjustment

[Michigan CG]

Maybe I am missing something but if the land value is well supported why didn't the adjustment get applied to the site value?

That is my first observation.

BUT, I have another.

We are talking about a single-family home. In my (relatively small) community there is a neighborhood of homes where absolutely nothing has sold for more $30,000 in the last eight years. In that neighborhood the land is basically worthless. If you own a vacant lot the chance of anything being built on it is less than zero. People give away this land or walk away and let the tax collector take it and auction it for $250 and even then it doesn't sell sometimes.

If you were to move the exact same home from the above neighborhood one mile west the value of the home could be in the $80,000 range. The land values in that west neighborhood are at best $10,000.

So a home with no land value that sells for $30,000 has all of its value in the improvements in the less desirable neighborhood.

The home where the price would be $80,000 has (at best) a land value of $10,000 leaving $70,000 in value to the improvements.

So how does one explain the other $40,000? It is external, but it cannot be attributed to the land as no one is paying anyone $40,000 to take their land in the less desirable neighborhood.

The above would indicate that the improvements suffer from the external above and beyond the site value.

Just to leave nothing out, what about a location adjustment of $40,000? Is not location external? And attributed to what?

 

[Fnbpos]

Hey there TXTEA.....did you happen to notice the last line of the Cost Approach ??? It says, "INDICATED VALUE BY COST APPROACH" That is VALUE my friend, not the COST by the Cost Approach.....its determining a VALUE. The top half the form is as you say, an exercise in COST. The bottom half reconciles the final number into a VALUE. A "VALUE" is created by measuring and reporting the various forms of depreciation. If the subject fronts a busy road and the market is saying a $20,000 deduction is supported, then a percentage of that market adjustment MUST go against the improvements in the form of external depreciation.

Good grief, where did you learn how to appraise ?. You are not alone, I've seen this before from many others. You must be one of those who has a SCA at $320,000 and Cost Approach at $375,000 because you don't account for all forms of depreciation. Good luck with that when the State throws a USPAP violation at your for being misleading.

 

[TXTea]

Good grief, where did you learn how to appraise ?. You are not alone, I've seen this before from many others. You must be one of those who has a SCA at $320,000 and Cost Approach at $375,000 because you don't account for all forms of depreciation. Good luck with that when the State throws a USPAP violation at your for being misleading.

Let's use your example then. If the market is telling us that proposed property A is worth only $320,000 due to external obsolescence but the true cost of the property is $375,000, wouldn't it be beneficial to the reader to see that? To see that the project is unfeasible to the tune of $55,000? If I embed the external obsolescence into the Cost Approach, then the reader can't really see it. Nothing is misleading, I'm just presenting it more clearly and obviously my reconciliation discussion would emphasize the Sales Comparison Approach. We're all in agreement that external obsolescence has a clear and measurable impact on the property. There is no USPAP violation here as you would suggest.

Now on a side note, I deal with external obsolescence quite a bit but none of those assignments have involved new construction and I have argued my way out of the Cost Approach, precisely due to external obsolescence out of fear of unintentionally providing a misleading conclusion.

 

[residentialguy]

Yes, as Rex Pete and Marion said, External Depreciation is adjusted on the cost approach...and it can be a substantial adjustment.

It is not, however adjusted across the board on comps UNLESS the subject is not experiencing it and the comps are; You only adjust variances from the subject on the SCA

This is appraisal 101, guys.

 

[residentialguy]

Let's use your example then. If the market is telling us that proposed property A is worth only $320,000 due to external obsolescence but the true cost of the property is $375,000, wouldn't it be beneficial to the reader to see that? To see that the project is unfeasible to the tune of $55,000? If I embed the external obsolescence into the Cost Approach, then the reader can't really see it.

They do see that. External Obs is a line item adjustment, it's not "embedded". Cost approach is an approach to VALUE, not cost. NOT showing it in any approach to MARKET VALUE would be misleading if it didn't represent Market Value.

 

[Pittsburgh Pete]

I don't have any weak understanding of any appraisal concept pal!!! The Cost Approach is a very valuable tool for me. I use it for feasibility studies. And I also use it in these cases right here. If you're adjusting for obsolescence in the Cost Approach, you're defeating its purpose. We're calculating the cost of the improvements and the market value of the land. Not the VALUE of the improvements. If you're looking at the VALUE of the improvements then what's the point? That's what the Sales Comparison Approach is for. Marshall and Swift? Don't need it, right, because you're calculating the VALUE of the improvements. Whatever dude.

Measuring "contributory" value of the improvements; you're a bit off in your understanding of the Cost Approach.

 

[hastalavista]

Let's use your example then. If the market is telling us that proposed property A is worth only $320,000 due to external obsolescence but the true cost of the property is $375,000, wouldn't it be beneficial to the reader to see that? To see that the project is unfeasible to the tune of $55,000? If I embed the external obsolescence into the Cost Approach, then the reader can't really see it. Nothing is misleading, I'm just presenting it more clearly and obviously my reconciliation discussion would emphasize the Sales Comparison Approach. We're all in agreement that external obsolescence has a clear and measurable impact on the property. There is no USPAP violation here as you would suggest.

Now on a side note, I deal with external obsolescence quite a bit but none of those assignments have involved new construction and I have argued my way out of the Cost Approach, precisely due to external obsolescence out of fear of unintentionally providing a misleading conclusion.

I hear what you are saying, but the approach to value by cost approach and a feasibility study/Capital Budget Model are not the same thing... although they use many of the same components.

The feasibility (or non-feasibility) of building the improvement would have been addressed in the H&BU as-vacant.

...Nothing is misleading, I'm just presenting it more clearly and obviously my reconciliation discussion would emphasize the Sales Comparison Approach. We're all in agreement that external obsolescence has a clear and measurable impact on the property. There is no USPAP violation here as you would suggest.

I may be misinterpreting what you are trying to say and if so, please correct me. What I infer from your comment is this:
For fear of having the intended user misunderstand the analysis, you alter it from what most would consider the recognized methodology (identify external obsolescence, if it exists, and apply it to the improvements, if appropriate). If I am interpreting you correctly, then I disagree with what you do. The process to address potential misunderstandings of the analysis is not to alter the analysis but rather to explain the issues in a summary of the analysis or in a reconciliation of the analysis. I'm confident you know this, so I'm unsure why you'd want to alter the analysis rather than address the non-feasibility of building a new improvement in those situations where that might be the case.

 

[Pittsburgh Pete]

Sounds like Tx is backing into his external obsolescence. If an "across the board adjustment" is made, backing into the obsolescence from the Cost Approach may be the only "solution" to estimating it (assumes there is no market evidence anywhere?) However, there are ways to support the estimate of external obs--one may have to reach back in time but the support should be there. Just takes awhile to find it.

 

[Pittsburgh Pete]

Maybe I am missing something but if the land value is well supported why didn't the adjustment get applied to the site value?

That is my first observation.

BUT, I have another.

We are talking about a single-family home. In my (relatively small) community there is a neighborhood of homes where absolutely nothing has sold for more $30,000 in the last eight years. In that neighborhood the land is basically worthless. If you own a vacant lot the chance of anything being built on it is less than zero. People give away this land or walk away and let the tax collector take it and auction it for $250 and even then it doesn't sell sometimes.

If you were to move the exact same home from the above neighborhood one mile west the value of the home could be in the $80,000 range. The land values in that west neighborhood are at best $10,000.

So a home with no land value that sells for $30,000 has all of its value in the improvements in the less desirable neighborhood.

The home where the price would be $80,000 has (at best) a land value of $10,000 leaving $70,000 in value to the improvements.

So how does one explain the other $40,000? It is external, but it cannot be attributed to the land as no one is paying anyone $40,000 to take their land in the less desirable neighborhood.

The above would indicate that the improvements suffer from the external above and beyond the site value.

Just to leave nothing out, what about a location adjustment of $40,000? Is not location external? And attributed to what?

If land is worthless, it lost value by virtue of its location--external obsolescence. What would it cost if not impacted by EO? You seem to say $10,000--portion of obsolescence reflected in the land.

 

[TXTea]

These are all very fair points.

For fear of having the intended user misunderstand the analysis, you alter it from what most would consider the recognized methodology (identify external obsolescence, if it exists, and apply it to the improvements, if appropriate). If I am interpreting you correctly, then I disagree with what you do. The process to address potential misunderstandings of the analysis is not to alter the analysis but rather to explain the issues in a summary of the analysis or in a reconciliation of the analysis. I'm confident you know this, so I'm unsure why you'd want to alter the analysis rather than address the non-feasibility of building a new improvement in those situations where that might be the case.

Very fair points from you and the others here and I don't disagree. I guess what I've been trying to say in my previous comments is this:

1) External obsolescence will usually poke its ugly head out in the land analysis, in which case most of the external obsolescence measured in the Sales Comparison Approach is accounted for in the site analysis in the Cost Approach. I suppose any leftover could be applied to the improvements I get that.

2) I avoid the Cost Approach like the plague when it comes to existing improvements suffering from external obsolescence because I find the Cost Approach to become an academic exercise in futility and probably not used by prospective buyers anyway. So I don't "alter the analysis" but rather avoid it altogether. The Sales Comparison Approach and Income Capitalization Approach (if applicable) are the two approaches to value I pursue in these cases.

3) I haven't had to deal with external obsolescence on new or proposed construction, but when I do, I would probably let the land analysis do the talking and try to avoid making additional subjective adjustments to the improvements if it even gets that far. The H&BU analysis would probably shut the whole thing down beforehand anyway. But I won't really know until something like this hits my office.