"Depreciation" (by definition) is a loss in value.
We (appraisers) typically attribute the deprecation amount to three different forms or causes: Physical, functional, or external obsolescence.
Depreciation is the loss of value.
Obsolescence is what causes the loss.
Most forms of obsolescence affect the improvements.
But sometimes, external (which can include economic) affect the site as well.
As a rule, we (appraisers) categorize that external influence as a form of obsolescence to
(a) the improvement, and /or
(b) as a loss in value (the site value) to the site.
Positive value influences that are associated with location typically accrue to the site value (better locations result in a higher site value).
Negative value influences that are associated with a location can affect both the site value and the amount of depreciation (external obsolescence) that should be charged against the improvement.
All of the above is basic Cost Approach 101.
Your question, however, opens legitimate discussion about a unique situation:
But what if the subject was located in good location? Would you put a (negative) value for the "external depreciation" in the cost approach?
(my bold)
When you say "negative value" in the external depreciation allocation, what I read you to mean is, "is it possible that something that positively affects the site creates a 'positive obsolescence' adjustment such that there should be a positive net adjustment rather than a negative net adjustment in the External Depreciation category?"
I'd say the answer is "yes", but it is complicated.
Assume a site's current zoning regulations limit its development to 4-units.
Assume the subject is an 8-unit improvement, and it was built prior to the current zoning density standards.
Assume the zoning ordinance allows existing densities to be maintained and rebuilt if damaged/destroyed, but if the site were vacant, it would be limited to the 4-unit density.
Assume that the value of an 8-unit income property at the site is more than a 4-unit property, and is so much more that any differences in RCN (cheaper to build a 4-unit vs. an 8-unit) isn't a factor. Yes, it costs more to build the 8-unit configuration but the income per unit more than compensates the additional cost. Anyone in her right mind, given the choice, would build an 8-unit property on the site vs. a 4-unit property. The only reason they wouldn't build an 8-unit property is because the zoning wouldn't allow it. But the subject's improvement is allowed because it is a pre-existing improvement and its grandfathered condition.
I think in such a case, when completing the cost approach, one must:
1. Value the site based on its H&BU as-if vacant (a 4-unit property)
2. Calculate the contributory value of the improvements.
3. Since it is a given (in my example) that the additional costs of building 8-units vs. 4-units on the subject's site is more than outweighed by the additional income, that value difference is going to have to be accounted for in the Cost Approach.
Value of the site is based on 4-unit density.
Contributory value of the improvements is based on the RCN less all forms of depreciation.
The value of the 8-unit configuration is more than the value of the 4-unit configuration and that gap is not explained by the difference in RCN.
The only way to address this (as I and an article in TAJ see it) is to attribute that difference to a negative (which results in a positive adjustment) external obsolescence factor.
By virtue of the zoning regulations, the subject has additional value (8-unit density vs. 4-unit) that is due to an external condition (legally permissibility, i.e. zoning).
Usually, this value factor would be addressed in the site value. But, in our case, our site must be valued at its H&BU as-if vacant and ready for development; if it were vacant and ready for development, it would be valued with a 4-unit density. It has an 8-unit density (more valuable).
The additional income of the 4 extra units more than offsets the additional cost of the 4 extra units.
So....
Yes, it is possible to have a positive adjustment for external obsolescence in the cost approach.
I think the situation where that would be necessary is rare. But I think it could happen (fortunately I haven't seen it yet in my practice!).
