External obsolescence prove it exists

[Brad Ellis]

Guys,

I think that there are really two questions here- one is measuring the external obsolescence and the other is the broader question is whether or not it is attributable to either land or improvements or to both.

Staying away from the measurement part, I am of the opinon that the loss is attributable to the improvments most of the time.

Using the example of the home on the busy street that loses income from its location- what if the externality were a railroad station causing it- say right across the street? Under SFR use it may well have externalities present; however if it were being used for say an apartment building and rents from a unit in that location actually exceeded rents from other competing buildings, would there even be any present?

If not, then the assumption that the loss is attributable to the improvements hold true.

Now I have not read the AI's most recent publications but other texts did say, if I remember correctly, that land does not depreciate. And then they go on to defeine depreciation as the loss in value form all causes from the upper limit.

So, if the loss is depreciation, and if land cannot depreciate (no one is saying it cannot lose value), then how can the loss be attributable to the land?

And of course, I see the conundrum in this- how can it lose value without depreciating? I've never had a firm handle on that part!

Brad

 

[xm39hnu]

(Joyce, are you SURE you've never been married to DB?)

Greg, I agree with Joyce, unfortunately. It was a grand try, and definitionally you're right. I'd forgotten about the age-old appraisal fiction that land does not depreciate, even though we define depreciation as a loss in value.

 

[Austin]

I think the missing link in this discussion regarding "depreciation of land" is the result of ignoring H & BU theory. The basis of the discussion debate in my view is the result of starting on the wrong end of the analysis by assuming a land value as a given. Land value is in a constant rate of change due to the principle of change and is always associated with the H & BU as of date of appraisal.
In a competitive market profit is fairly well fixed. No one is going to build a dwelling and make a 25% profit, not for long anyway and even if they so others can do it too. In the cost approach the profit is part of the equation and must come from the market. Remember the discussion we had a while back about using industry ratios to breakdown property components as a method of extracting the income allocated to the real estate in going concern sales to support an improvement value? Same goes for the cost approach. If you do a highest and best use analysis for example and the H & BU is an average quality rancher worth $100,000, then we apply the industry ratios. If the profit is 10% when that leaves $90,000 for building and land. The next given is the cost of an average rancher extracted from the local market at say $70,000. These are industry ratios extracted from the market. That leaves $20,000 for the site and land is a residual value.
The reason land can't depreciate is that it is a residual. Just because the land is worth $20,000 today and next year is worth $15,000 is not technically due to depreciation, it is due to a change in H & BU meaning the building is no longer the highest and best use of the site. Think of land value as a shadow. It reflects what is above it but it has no substance. It is what it is. It is here today and gone somewhere else tomorrow.

 

[jay trotta]

Ben

thought I would reference some old books, so here goes, take from it what you like;

Obsolescence: Caused by changes in types and methods of construction, style of archetecture, interior arrangements for specific purposes which render a particular building out of date. Changes in the use of neighboring property may also contribute to the obsolescence of a building.
From: Robert W.Semenow, Professor of Urban Land Studies, University of Pitt., 4th Edition, (1964) (1st printing-1961) Pub.Prentice Hal, Englewood, NJ

Over-Improvement: An improvement to Land that is more extensive or costly than needed. As an example, the erection of a thirty-story office building where fifteen would have been adequate for the present and forseeable future needs of the business community. The resulting empty space provides no return to the owner. The market value of the property, as well as the surrounding land, is correspondingly lessened. Also called a "Misplaced Improvement"; the opposite of "Under Improvement".
From; Jerome S. Gross, Dictionary of Real Estate - 1969, 1978, 1987, NY

From back in the day, these tidbits have been part of the history and I'm sure reviewed by many in our field over the years. Perhaps, may have even influenced some interpretations. Reference books are a great source, build your library, your future may depend on it.

snowglobe inner workings......ROFL

 

[Fred]

Austin’s theorizing brings out a key point

The idea that the contributory land value in an improved property is the same as what vacant land sells for is a theory, maybe even just an assumption – although, I would agree it is the assumption that makes the most sense. That’s one of the reasons the idea that land is appraised as though vacant was removed from USPAP. The ASB explicitly stated in the draft that there is more than one way to skin that cat. That is, there are a number of theories and assumptions that can be used to appraise the parts of properties. It's just that most text state the same assumptions for the for the cost approach, the land should be appraised as though vacant. That is why the "loss" attributable to land goes with the land value, and the "obs" only goes to the building.

It gets to the larger question of appraising the parts of whole properties, which in my opinion, are the most complex appraisal issues and often cannot be resolved. I have always found it interesting that once the topic moves toward the cost approach, that appraiser gloss over the assumptions, hypotheticals and difficulties that would ascribe to appraising pieces.

 

[Austin]

What Jay just posted above is exactly what I was addressing in my above post-it is all goes to highest and best use. Some have lost their point of reference on this subject. All obsolescence is in relation to the H & BU as of date of appraisal of the use that fits all four H & BU requirements. Then you must conform to the 11 economic rules underlying the theory. You have to be consistent throughout the process. That is why I don’t understand people that say the cost approach is not relevant. It is like saying the north star was not relevant to navigators over the years. We must have a point of reference against which to measure obsolescence and H & BU of the site as of date of appraisal is the point of reference. Highest and best use as improved is a different problem but even then it can't be solved without knowing the approximate site value to support the basic assumption that the highest use is generally as improved subject to repairs, alterations or whatever.

PS: The root of this problem is in my opinion GSE appraising in which the highest and best use is a predetermined conclusion. That monkey on your back you have to fit a round object into a square hole.

 

[The Warrior Monk]

The idea that the contributory land value in an improved property is the same as what vacant land sells for is a theory, maybe even just an assumption – although, I would agree it is the assumption that makes the most sense.

I figured this one out a long time ago. Long ago, I couldn't make sense of the vast differences between what vacant land was selling for and what improved lots were selling for, when the improvments contributed little to value. In these particular situations, improvements were located in preexisting locations, and the fact they existed was important, not what existed.

Assuming the land is vacant means the property may not be able to be improved, so the lot has little value. The land then would have to be valued under the hypothetical conditions that it is vacant and that it is improvable if one is taking that approach.

 

[Joyce Potts]

(Joyce, are you SURE you've never been married to DB?)

Greg, I agree with Joyce, unfortunately. It was a grand try, and definitionally you're right. I'd forgotten about the age-old appraisal fiction that land does not depreciate, even though we define depreciation as a loss in value.

Jim,

I think the better question is was DB (Doug Bingham) ever married to me.

And the answer is no. But he must be an admiral guy and I'll take that as a compliment even if it wasn't meant as one.

 

[Steve Owen]

In reference to Austin's last post, you should not forget that most appraisals have two H&B Use problems to solve. What is the highest and best use of the land, as if vacant; and, what is the highest and best use of the property, as improved?

In some, more theoretical situations, such as valuing leases, or business valuation, appraising the land, as if vacant, might not be necessary; might not even make much sense. But, for most improved properties, when the appraisal is for valuation of the fee simple ownership interest, then looking at the value of the land, as if vacant, usually makes the most sense.

Here is why. Obsolescence, by definition, only applies to improvements... land does not depreciate. However, land can have very different values, depending on what is around it and where it is located. Kind of looks like external obsolescence, doesn't it?

But, it's not, IMHO, and here is why. If you first value the land, as if vacant, at it's highest and best use, you find a value that might or might not be consistent with current use. When H&B analysis is then applied to the property, as improved, it will start to give you an idea of external obsolescence. Of course, there may also be other kinds of obsolesnce... other factors to consider. But, in a "clean" problem, the difference between what the building would contribute to overall value if improved at H&B Use and what it actually does, is likely attributable to external obsolescence.

Austin had a pretty good explanation with the railroad station example. But, a simpler way to put it would be that in the busy location, the improved property might lose value, as improved, at the same time that the land, as if vacant is increasing in value.

Why doesn't land suffer from EO? The easiest explanation is that it does not by definition.

 

[Fred]

That is why I don’t understand people that say the cost approach is not relevant. It is like saying the north star was not relevant to navigators over the years. We must have a point of reference against which to measure obsolescence

I have done everything I can to point out that “reference” you need is replacement cost only and doesn’t entail the “approach” to market value part. In fact, what I keep seeing is explanations that show how the cost approach depends on value found elsewhere, rather than find anything on its own.
Go back to post 130 where Jim extracted the location difference and post 131 where Greg, broke it down, $7,000 by land values and backed into the external obs for a cost approach. These demonstrations of making the cost approach “work,” always seem dependent on already knowing what the property is worth.