Functional Or External Obsolescence?

[hastalavista]

From the Appraisal of Real Estate (14th ed.):

"The cost to construct an improvement on the effective appraisal date may be developed as either the estimated reproduction cost or estimated replacement cost of the improvements. The theoretical base (and classic starting point) for the cost approach is reproduction cost, but replacement cost is more commonly used because it may be easier to obtain and can reduce the complexity of depreciation analysis....

....The decision to use reproduction cost or replacement cost is often dictated by the age of the structure, its uniqueness, and any difference between its intended use at the time of construction and its current highest and best use. In theory, the use of either reproduction cost or replacement cost should yield the same indication of value after proper application...

...Estimating reproduction cost can be complicated because the improvements may include materials that are no longer available and construction standards or codes may have changed. Nevertheless, reproduction cost usually provides a better basis for measuring depreciation from all causes when that sort of measurement is necessary."
(p. 569 & 570)​

There. All the relevant pro's and con's regarding Replacement vs. Reproduction.

Pick your poison and good luck!

 

[Terrel L. Shields]

The property is going to sell on the basis of the land. It is a ranch, not a home.

 

[Fnbpos]

Functional impacts the improvements only; if the site is not impacted, then it is functional; thus the original examples are ALL functional. Some say the use of Replacement Cost eliminates all functional depreciation. I disagree; it does eliminate quality issues and inadequate floor plans among others but is would not eliminate a size over-improvement because I must still replace that 28000 sqft house in the Cost Approach.
As for external...well that impacts both the improvements and the site; that is why that $25,000 market discount for baking to the Interstate highway is allocated to the site and improvements in the cost approach proportionally. Don't see many appraisers get this correct (sad to say)

 

[Terrel L. Shields]

it does eliminate quality issues

I don't read it that way...

RCN should replicate the same function. That does not mean an over-built home should be the same function as a manufactured home. It presumes some similarity with quality, size, and style. But it does not require the same methods of construction, materials that are obsolete, etc.

As for this property having only an element of "functional" obsolescence, I have to go with the thoughts from the literature...you know those things USPAP require we keep up with. Externalities refer to the influences within the "market in which the subject property competes" - that's a quote from an AI text. IF a property has a national market (i.e.- premium executive retreats, etc.) then it does not compete with the 2 acres and a rancher next door. It competes with other dwellings with large acreage tracts that may be far away. That influence is off site. Graaskamp, Carr, and lots of others have discussed that issue, and yes, it is and can be a very gray area. It is the decision of the appraiser whether the influence is functional or external. And many authors comment that there is a blurred line between such influences being "external" (a reaction to market influences) or "functional" - aka, overbuilt. So I would want to vet the dwelling considerably. Quality, age, dated designs, etc. First, there is likely some functional element to the property. But the question is if this house was sitting in the edge of Thermopolis or Jackson Hole, would it be as affected as if far distant from those areas? I would suggest that it would bring more closer to town, and that the dwelling would contribute more overall to the property. That differential is an artifact of external market influences, not the design of the dwelling itself.

The reference I gave above - the Open Fences Magazine of luxury homes - has a lot of homes that are over-priced. No small number of them do sell however and they sell for a premium reflecting their unique character. And any property with 28,000 acres is a "unique" property by definition. The question is does the dwelling contribute less due to its market position, or can we account for all the functional issues without looking at the bigger picture and bigger market. If a property can be influenced by it location positively, then it can be influenced by its location negatively...which is the definition of locational obsolescence and locational obsolescence relates to external obsolescence.

So if the following dwelling was not located near Walmart Headquarters, would it bring the price it did? Is location influencing the price? Then if moved 30 miles away, does the functionality of the dwelling change? I don't think so. It is the location that influences the price therefore it is locational obsolescence. Again, not that functional obsolescence won't exist too.

 

[Mark K]

Functional, the neighborhood was there first.

Someone built the "wrong" improvements.

 

[Terrel L. Shields]

The literature says it can be looked at either way and probably more lean to "functional" but for some the idea is that there is nothing there that is not "functional"...it is in the wrong market and will be impacted by locational obsolescence....which is clearly external obsolescence.

 

[Restrain]

I am going to go back to Terrel's earlier post. Stop over thinking this. You are valuing a 28,000 acre ranch. The buildings are a very small part. You are looking at the overall operation, probable long term use of the overall property. Do NOT treat the residences like a typical residential appraisal. Rather you are looking at probable contributory value of the improvements. Think how storage buildings on a custom estate property contribute to value. That is what you are dealing with here.

 

[Mr Rex]

I agree. The typical buyer of a 28,000 acre ranch is not likely to bat an eye at having to remodel or add an appropriate kitchen and a garage etc. In the grand scheme of things, I suspect the things you seemed concerned about are nominal factors of the overall value.