External depreciation

[Ray Ohler]

If I read Koert's post right, OK, it COSTS the same to build the house but what is the impact on VALUE? In a new construction setting you are usually working in a "controlled" market. If THIS buyer won't pay the builder's price, another one will. Doesn't mean value = cost. The improvements ARE impacted by the external factor.

 

[Austin]

Ray & Koert: I think the questions you guys are raising concerns functional and economic obsolescence. For example, if you build a house in an industrial district, you create functional obsolescence in the property. If the industrial area moves into a residential area, any decrease in prices would be economic obsolescence in the existing dwellings. Although the location of these conflicting uses causes the problem, I still say location is a different ball of wax relating to time-distance relationships. This is a complicated subject. If we used the correct sequence of adjustments and ample comparable sales, 99% of the guess work would be taken out of the process.

 

[Ray Ohler]

If you built (newly constructed) dwelling in an industrial area I believe you would have a H&B Use problem not functional obsolescence. If it was an "existing" home, I believe you have an external obsolescence problem, not a functional obsolescence problem. You could cite 100 different examples and bring up 1,000 different variations. It all depends on a myriad of other factors. What I was getting at was cost versus value. If Koert meant "price", just susbstitute price versus value. Not always the same thing. However, because FNMA is willing to accept the "price" as being "value" watch out, that is one of the reasons why the appraisal "profession" is becoming a target to be eliminated. For all the "honest" deals? No problem. For all the coming "dishonest" deals, move out of the way, here comes Enron. Yes, I am being a little of an "alarmist" but only to indicate my stand. I personally know quite a few appraisers WHO NEVER cut a value, even when shown substantive evidence that it SHOULD have been cut. Used to be very few, then a few more, now quite a few. Who knows, maybe I have blasted off the planet.

 

[Richard Carlsen]

Two houses, identical market acceptable floor plans. One in industrial area, one in totally residential area. Conclusion: neither has functional since they are the same. The only difference has to be external. Remember that external is what effect value outside of the property boundaries. It is either economical or environmental. The fact that families do not want to raise their children in amongst factories is economical (it is market driven and therefore economic).

Functional has to do with the improvements themselves. Two houses, side by side, both built the same year and both 1800sf. One market acceptable traditional ranch style house. The other a 1 story cobbled up mess that has been added to 4 times with no overall continuity of design. If the ranch style house sells for more than the cobbled up house, the main reason (all other things being equal) would appear to be functional obsolescence.

Don't make it hard. Functional concerns the improvements themselves and the market reaction to them. External concerns those things outside of the property that effect value.

 

[Austin]

Richard: My examples of functional and economic I used in my above post were questions on the state appraiser exams. If I remember correctly, the questions related to: economic obsolescence occurs when an area is in transition to a higher use like from residential to commercial, and a form of functional obsolescence is when a lower use like residential moves close to commercial areas. Apparently functional has to do with not only design function but neighborhood trend. Neighborhoods in transition are a special case of something. I think the rub is that when land to building ratios change the contributory value of the improvements change and the economic life is affected. Whatever you call it, lack of conformity equates to lower prices in general. Apparently this is another area with divergent opinions in high places. Just another reason I am suspicious of reviewers.

 

[KD247]

Interesting replies regarding external obsolescence- this is clearly a non-clearly defined concept.

To me, depreciating the improvements for external obsolescence implies that a piece of lumber, a dishwasher, or anything else that goes into a building are worth less than the same items on a site that has "no" external inadequacies (if such a site could exist).

I've never seen an example of this. What I have seen is reduced site values to compensate for the external problems.

Adding the elements of time and functional problems with the structure makes the problem more complicated, but it seems to me that any external problems can only affect site value.

It's Friday - I'm buying! See you at Tacos & Beer in about an hour.

 

[Farm Gal]

Koert:

There are a large number of properties in the local innner city market which can only be explained by external. Verifiable site values can be under $500.

Physically depreciated improvements less site value still far exceeds the sales in the area. So we either have 'severe negative site value' OR external depreciation.

Front page news yesterday was an article about it being dangerous to walk in some of these areas after dark, that area personal crimes (inclusive of auto burglaries) exceeded (I think it was) 40% !!! etc, etc.

Aside from 'External Depreciation' I do not know any other way to describe what is being observed in the market! Move the improvements 2 miles away and thier value doubles. The site cost cannot not explain the difference in value.

I have a lender who was VERY angry when I did an REO appraisal on a property and came in far far below the paper they are holding. I stated clearly that the H&BU for the site was as vacant and donated - rather than sold (with foundation intact) to Habitat for Humanity for the tax write off(!), and suggested moving the near new and quite upscale doublewide that sat on that foundation to ANYwhere else in town or out in the country. They were NOT happy. Property has now been on the market for over 7 months at a listing price only slightly higher than I appraised the property 'as-is' .

Thus MY case that 'real' external depreciation can exist!

Any thoughts?

lp

 

[KD247]

Lee Ann -

Obviously, my thoughts on external obsolescence aren't fully formed, but I have a sneaking suspicion that your scenario is probably close to the best example available.

On a hypothetical site with little or no value (or even a negative value due to liability), it's easy to imagine a case where improvements could add no value at all. But - is this a case of external obsolescence or functional obsolescence. Maybe my whole problem is that - for me - the distinction between the two is not clear. After all, isn't functional obsolescence often due to economic and social influences, which vary from area to area?

The more I learn about appraising, the more I wonder whether some of our "guiding principals" are really that thoroughly thought out. I remember squirming in my seat as I learned about matched-pairs-analysis because the instructor had no problem violating the most basic rules of statistical analysis.

You're brave to do appraisals in those inner-city areas. I've had a couple of experiences with tough looking kids blocking the street and just staring me down. Never any real trouble, but it's unsettling!

Thanks for your post - not many of my friends enjoy discussing appraisal theory!

Koert

 

[airphoto]

I typically take external obsolescence for such things as:

1. Poor economic circumstances of the county

2. Poor reputation of the school system

3. Embarrassing performance of the local elected clowncil

In addition to the boarded up, bombed out abandoned properties observed within site of subject ..

 

[Farm Gal]

Thanks Koert! I suspect that there are areas of the country that do not have these issues, wish I lived in one of them - I'd have less grey hair and more money- write 'em and roll em! I sort of think of it as job security: no AVM is going to be able to sort this matter out. I may attempt a poll on this matter :idea: : any suggestions on how to word it so we get valid feedback?

:lol: Bill, our area has all three of the circumstances you mentioned! :lol:

Interestingly I CANNOT find any specific reasons why some areas are better or worse than others and believe me I have looked. :?

Coming here from out of state I certainly had every reason to question "WHY" when I got here, as appraising with out the 'everybody knows' one area versus another information was pretty scary. I spent several years asking awkward questions and trying to define the why's. I am still asking...

Schools are part of it, flat out economics of inhabitants certainly another factor, Race IS a minor portion (like it or not folks), but there are so very many areas here where the cars and the faces and the wages and the schools are the same, yet block A versus three-four blocks (let alone a mile) away will vary in price considerably "because". I still question and try to determine the answer to "because why?" , but the fact of the matter is there is an external depreciation difference between certain areas for no verifiable reason other than buyer (and realtor) perception. Some of these properties fall below the threshold where realtors care to facilitate the transactions, thus it is PURE market transactions!! So: "external depreciation!"

And THAT folks is why in my area at least the AVM's do not scare me too much, although I have often wondered if (shudder) implementation of area wide AVM's might not cause a leveling off of values so that it makes sense... and effectively eliminated the possiblitity of 'fair houseing violations' which may be holding some areas down unrealisticcly.

A few lenders would get badly churned by sharpies who would sell sell and take the money and run.... :roll:

The REO's would roll over and the better qualified appraiser detectives (who sorted out the flips) and took an honest look at the improvements would write and so it goes...

Lee Ann