External Depreciation Adjustment

[Fnbpos]

Good to hear someone is learning something, that should be a benefit of this forum; however the statement:

"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."

......tells me we have a way to go here. External Depreciation would NOT be even remotely accounted for in the CA within the site analysis only. The only way this is possible is if the site represents MOST of the total value. In most cases, the External depreciation is allocated more to the improvements than to the land because the improvements contribute a higher percentage of the total value than does the land.

If the market supports External Depreciation against the subject at $25,000 (the adjustment in the SCA) and the Site Value reflects 20% of total value; then 80% of the $25,000 must be deducted from the improvements. That large number is NOT accounted for in the site analysis. (When site sales are actually available, it is not always this "clean", but that's why this isn't a science).

BTW....this is appraisal 101 course material.....

It would be wise to do the analysis as intended or risk misleading the intended user.

 

[TXTea]

If the market supports External Depreciation against the subject at $25,000 (the adjustment in the SCA) and the Site Value reflects 20% of total value; then 80% of the $25,000 must be deducted from the improvements.

If site value is already $25,000 lower than what it would be worth otherwise then employing the "appraisal 101" method you prescribe causes the appraiser to effectively double-dip.

 

[hastalavista]

I am looking at a report where the appraiser states that a property suffers a 12% penalty for external obsolescence due to its location on a collector road. The 12% penalty is applied to the cost approach, and the dollar amount is then applied across the board in the sales comparison approach. This is a 70+ year old home where the cost approach is likely meaningless in the first place. I think this methodology is correct when accounting for deferred maintenance but not for external issues. My way of thinking would be to apply the 12% penalty to the unadjusted sales price of the comparables. Thoughts?

(My bold)

I never answered your specific question (Howard pointed this out to me).
No: Applying the 12% external obsolescence adjustment calculated in the Cost Approach would more likely than not be incorrect. Assuming that the externality impacts the land and the improvements, the 12% adjustment in the cost approach only addresses the impact on the improvements. Unaccounted for in that 12% is the impact to the land (that, presumably is baked into the land value opinion). So, unless the external obsolescence is all on the improvements and not part of the land value, applying the EO cost approach adjustment in the SCA grid would be incorrect.

There are times when the adjustment in the cost approach is the correct adjustment to make in the SCA.
If the floor plan of a house has been altered, the alteration impairs the house's appeal in the market, and that impairment impacts value by $15k, that would be reflected as a functional obsolescence adjustment in the Cost Approach and a $15k functional utility adjustment in the sales comparison approach.

 

[Deleted member 80407]

I am looking at a report where the appraiser states that a property suffers a 12% penalty for external obsolescence due to its location on a collector road. The 12% penalty is applied to the cost approach, and the dollar amount is then applied across the board in the sales comparison approach. This is a 70+ year old home where the cost approach is likely meaningless in the first place. I think this methodology is correct when accounting for deferred maintenance but not for external issues. My way of thinking would be to apply the 12% penalty to the unadjusted sales price of the comparables. Thoughts?

If I were reviewing or looking at this report, I would be looking for paired sales to support the 12%. Not considering time, paired sales can generally be found within the market. Even if the sale found for comparison is 10 years old. Once a comparable sale(s) are found, one can find comps of non-arterial street locations during the same time period and dividing the interior street location to the arterial street location to find a percentage adjustment. Usually percentage adjustments will not change over time. The only thing that changes over time are values. STRAIGHT ACROSS THE BOARD ADJUSTMENTS SHOULD NEVER BE UTILIZED WITHOUT SUPPORT.

 

[Fnbpos]

If site value is already $25,000 lower than what it would be worth otherwise then employing the "appraisal 101" method you prescribe causes the appraiser to effectively double-dip.

What you are saying by your example is that the external influence has no impact on the improvements. You are saying the external influence ONLY impacts the site, not the improvements. Please reference even one publication that pushes that theory ??? just one.

If you buy a lot on the highway at a discount and then put a $750,000 house on it, the market will penalize the house also for the external influence. The market does not live on the vacant lot; the market lives in the house which suffers from the noise. The house costs the same as an model match 4 blocks away from the highway, but will be (or should be) worth more than the subject. When I find the deduction for the loss in the SCA, say via paired sales analysis, that deduction includes the improvements and site by way of the sale price.

As for a functional adjustment example.....that will only impact the improvements. The lot is not impacted. You would be surprised (or maybe not) how many appraisers confuse functional and external - I see it all day, everyday.

From Appraising Real Property, Boyce, etal: "Charges for accrued depreciation are made against the improvements only. They are deductions from the reproduction/replacement cost new of the improvements. Site as such does not depreciate. This fact is particularly IMPORTANT IS ESTIMATING LOCATIONAL OBSOLESCENCE. Only the portion of locational obsolescence that is allocated to the building is a deduction. Otherwise, there would be double counting and excessive charges, since the estimated market value of the site already reflects the negative locational influence."

If your improvements reflect 70% of the total value of the property and you are not counting an external factor against those improvements, then you have an error. If you use vacant site sales to determine an external loss to the ENTIRE improved property, then you are under-adjusting because you have not considered the impact of the external loss on the improvements. All you did was support the subject site value, not a total market adjustment for the external influence.

 

[TXTea]

All you did was support the subject site value, not a total market adjustment for the external influence.

I think I did actually. Because according to you, the total market reaction for external obsolescence was $25,000. So I just pointed out that if the site's value was actually $25,000 lower than what it would have been valued otherwise, then there isn't any more room for an adjustment to the improvements. If you make an additional adjustment to the improvements then your Cost Approach conclusion will be too low.

Look man I'm off this thread. You guys are academics. And academics should stick with academia and stay off the streets. Mmmmkay?

 

[hastalavista]

Look man I'm off this thread. You guys are academics. And academics should stick with academia and stay off the streets. Mmmmkay?

I consider myself to be a practitioner... but if applying the recognized methodology correctly makes me an academic, I'll happily wear that mantle as well.

 

[CANative]

Denis being measured for his mantel.

 

[CANative]

EO in the CA doesn't automatically transfer to the SA, What if all the comps are next door to the subject and are subject to the same adverse external influence?

 

[J Grant]

It costs the same to build a 2000 sf lot next to a busy highway as it costs to buid that same quality and size house on a quiet street.

If 10 years later they both go up for sale, and the house A next to busy highway sells for 250k, and the same house B on the quiet street sells for 300k, where was the loss of value...to the house, the land, or both as a package?

That to me is the problem of methodology vs what happens in the real world/ how buyers see things...and perhaps reconciling the two is an art form (or BS...lol)

A buyer looking at house A and B could care less what the vacant land sells for, they are not planning to build a house on vacant land. They just know they have the choice of identical houses, one with noisy traffic street one on a quiet nice street. Assuming they follow typical pattern, a bargain hunter buyer would buy the lower priced house A) (lower price because it sat on market a year at higher price with no takers and was just reduced), and the buyer who valued their peace and quiet happily pays more for house B.

So to the buyer, and seller, the loss is the house and land as a package. The seller could only get X $ for house on busy road, and could only attract bargain hunter buyer to it for X $.

To an appraiser, they might say all the loss was in the land, since if the houses were removed and suddenly both sites vacant, theoretically, site A would sell for less than site B. The problem of course is there are no vacant site sales to be had for over a decade..but taking at face value a vacant res site would sell for less on a busy road then same size site on quiet road, . it still costs Y$ to build the house. So on the next sale market will show the improvement also looses value dollars relative to what it cost (obsolescence)