There's an opinion that says external obsolescence to the land is reflected in the actual land value.
Thanks Jim, I thought everyone was completely losing it!
The three approaches to value, I assume, were at one time similar to the three branches of government, providing critical checks and balances.
The Income Approach was based on the precept that investors (or owners) would not pay more for a property than it was capable of producing, relative to the return on other competing investments.
The Cost Approach presumes that a buyer will not pay more for a property than the cost to build a similar property (plus a factor for the development risk and effort).
When the real estate boom began, instead of double-checking our opinions against all three approaches to value, we merely rationalized the weighting of the Sales Comparison Analysis. After all, that's what the market showed it would pay for a property.
But, if we had taken a closer look at the Income Approach we would have realized that, except during boom times, people are generally reluctant to make mortgage payments that exceed rental costs.
And, except in boom times, buyers are generally unwilling to pay more for a property than the cost for which they could build a similar property.
So, what happened? Investment buyers started included anticipated appreciation into their cash flow and were happy to buy investment properties that returned 0% cash-on-cash because they knew they could look forward to hundreds of thousands of dollars in profit upon resale.
Homeowner-buyers began to ignore the alternative of building, because a completed property would appreciate so much over a year that it just made no sense at all to spend a year building a property, even if there was tremendous compensation for the effort to build.
And so, buyers ignored two important value checks, the Income and Cost Approaches, and appraisers followed suite as we conjured up rationalizations that let us develop opinions of value at the popular point, defined by market vagaries and uncommitted buyers, and illustrated by the Sales Comparison Approach.
Had we adhered to the principle of three approaches to value, these checks and balances, much irresponsible lending would have been curtailed. As we find values hurtling downwards, appraisers are again talking about the fundamental value of real estate (based on investment returns and rent/own tradeoffs) and using the Cost Approach as a check on the upper limit of a property's value.
What does this have to do with External Obsolescence? Many appraisers have developed the habit of using External Obsolescence as a rationalization, with no logic or consistency to back it, the same way that most appraisers include the statement that buyers don't recognize a relationship between rental income and value. (The rent statement is true, but should not be used as a justification to categorically reject the Income Approach.)
So, when the Sales Comparison Analysis and the Income Approach don't jive, just chalk up the difference to External Obsolescence.
Why is that wrong? Because the Cost Approach is static, and deals with a specific point in time. External and Economic Obsolescence occur over a period of time. Regional material and labor costs are the same, no matter whether they are placed on the subject lot with External Obsolescence or a superior lot four blocks away. The way the Cost Approach is presented on the 1004, all External Depreciation is attributed to the improvements while, in fact, any external or economic influences occurred over some time period prior to the appraisal and are reflected in the current Site Value.
Yes, External Obsolescence and Economic Obsolescence are real. They are measures of value loss, over time, due to forces external to the subject property. No, there is absolutely no sense to the way that External Obsolescence is shown on the URAR. The External Obsolescence field is merely a last-ditch effort to cram an important concept into a place where it doesn't logically belong.
Should changes in value due to external or economic forces be mentioned in the appraisal? Absolutely yes. Should there be an adjustment in the Cost Approach? Absolutely not, the lowering of values will be reflected in the Site Value. To say that external or economic forces affect the price paid for materials just doesn't make any sense at all.
