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Functional vs External

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Anonymous

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I know I am being redundant. But this come up in McKissick’s Oddball Non-conforming properties class (Lee Westendorf, inst.) compliments of yours truly.

Two markets in one county. Wally World and the hinderlands. Wal-Mart is where the money is and where the towns of Rogers and Bentonville are. Wal-Mart put them on the map. The executives who work there, Wal-Mart & vendors, want their kids in local schools but many want into upscale gated communities or larger rural tracts. In those school districts agriculture has pretty much been eliminated and replaced by non-economic executive estate farms. In the hinderlands (west side of county) agriculture still thrives and the small towns (Gravette, Gentry, Decatur, & Siloam Springs) have cheaper property both vacant tracts and housing. The least differential is between modest older homes. Until 5 years ago I know of no newer executive house in the Gentry School district of over 4,000 SF, nada, none. There are now about 4 such homes. Perhaps 5 -10 in Siloam Springs, all custom, all not for sale. The only one for sale is in Gentry [5,119 SF on 66 acres] and the asking price is $499,000 recently put back on the market after a hiatus and was previously offered for $599,000 more or less for a year (1999-2000). The owner is an airline pilot. School district not so important to him, but Wally World execs want to stay inside Bentonville or Rogers school district because they can go to the school easier, the schools are larger (maybe better), and it would be very inconvenient to drive 30 mi. from work to hinderland school, and back if you have a sick kid, etc.
New construction in Gentry School district. 89 acres. 4500 SF. Sprinklers, 1300 foot deep water well, $12,000 just to gravel the driveway (which will flood anyway.) Owner is a builder in Wally World, building $300,000 spec homes and owns a manf. Plant in hinderlands. He is building near his church (7th day Adventist) and his kids would go to Adventist school. Your comps can only come from Wally World. And they do not suffer obsolescence due to demand for such properties...i.e.- they are typical for the area and not overbuilt. Demand is zip once you cross that school district line. There is little demand for executive homes in this working neighborhood.

Clearly, the house is overbuilt in this market, but how do you demonstrate it?

QUESTIONS....
If the house is overbuilt, then the resulting obsolescence is incurable functional OR

the externality that affects the value is the lack of market, thus the obsolescence is incurable external (economic)

The instructor opts for the former and compares it to a Dome home. But a Geodesic Dome home is incurable in any market I have ever seen. The subject property is perfectly functional if only it could be moved 10 miles east. And if the market changes, the obsolescence disappears. Say,
Ford Motor decides to build a plant in Gentry. I personally think it could go either way. But the real question is how do you measure obsolescence of a house such as this. This house is the same market pariah that a Dome home would be..simply too few buyers in the market for such a home. But reasonable comps do not exist in this market and since no houses even similar exists you cannot go back in time. You are forced to use much smaller comps from the area, or equal sized comps from the area where there is no obsolescence. You cannot estimate the obsol. based on smaller homes, because there are buyers for homes in the 100 - 300K range, just not above it. You have to make a “trust me” adjustment?
There is no basis for paired sales adjustment, no basis for rent based adjustment, no time discounting for extended marketing time because we haven’t seen one sell yet. whatta you do? Poll a bunch of rich folks at Wally World and see what they would discount for moving from Bentonville to Gentry?

The rest of the story. I got reamed by the builder who is incensed I would take a deduction (he doesn’t see why because the houses he builds in Wally World sell just fine.) The banker does not have a clue since he lives there, too. And I have no clear cut evidence to support the adjustment, except the knowledge that none of these houses have sold yet and only 1 or 2 have even tried. I do know the pilot and they get a few lookers, but have no offers yet. Same old story. Wrong school district.
 

KD247

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California
Terrel,
What a mind-bender! It sounds like the subject's value range is clearly between $300,000 and $499,000 but with the poor marketability of the pilot's house, I'd stay far away from the upper part of that range.

My first thought was that if nobody is building similar homes, there may be almost no demand for them, with almost 100% functional obsolescence for everything over $300,000. But, you mention that there are 5 or 10 similar homes built in the last five years. Can you analyze these properties by using the owner's total costs in place of a sales price?

My next step would be to expand my search parameters to find a similar situation, even if it's a long ways away, but you probably would have already done this if it was practical.

Nobody knows the market like the market. I think it would be perfectly appropriate to interview buyers and agents and see what their response to the subject would be.

I side with you on the Geodesic Dome analogy. I would assume that anybody in the area would prefer your subject, at the right price.
 

Austin

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Virginia
Terell: The question you are faced with is not an appraisal problem but a problem for Mrs. Cleo. If you build an expensive dwelling in a location where there is no market for that type property in violation of the principle of highest and best use, you just screwed up. I don’t see why you want to get into some arcane argument about what form of obsolescence to call the screw up. You seem to be struggling with the question of how to extrapolate some measure of obsolescence from less expensive dwellings but extrapolation beyond the range of data is voodoo, not science. It is probably not what you want to hear, but in my opinion there is no appraisal solution to this problem. You can’t measure any value factor that is not bracketed by sale data because if you do you are extrapolating. The sales have to bracket the subject not just in size and price but also in all major value influencing factors. For example, a $40,000 in ground pool in an area where there are no other pools. How much does the pool contribute to value? The answer is, nobody knows. Remember the nursery rhyme about Humpty Dumty. Humpty Dumty sat on a wall and Humpty Dumty had a great fall. All of the Kings horses and all of the Kings men couldn’t put Humpty together again. When you miss the highest and best use when you construct the over improvement, all of the Kings appraisers can’t undo your screw up with arcane explanations of what type obsolescence to blame it on. I guess that makes it functional obsolescence but as they say, a rose by any other name smells just as sweet. I never make adjustment for anything I can’t support with data. The last time I got into this situation was a proposed construction appraisal on a 2,000 square foot dwelling with a contract cost to construct of $380,000. I picked about 30 of the most expensive sales in the 18 to 2300 square foot price range from the local market, did a regression and graphed the predicted prices and the actual prices versus the gross living area. The trend line was tight with a small variance meaning all of the comparable sales were clustered close to the trend line but the subject was stuck way out of line and almost off the graph. The bank CEO called me in to ask about it. I showed him the graph and told him a house at that price with that GLA was totally out of balance with the market trend line. He asked if the quality of the neighborhood couldn’t account for the difference. I said yes but there were no sales in this neighborhood to support that for that size dwelling. You can’t do a highest and best use analysis if you don’t have some idea of a market supported price. If you do, at that point in time it ceases being an appraisal problem. Any time you see a land to value ratio between comparable homes way out of line, that should tell you something. Land price is a given and reflects market balance in that market. If the land is cheap as compared to other areas as in your example, what does that tell you about the market for expensive dwellings? The CEO asked me what to do and I told him to show the client the graph and tell him he was flying solo. I know what your problem is. If you don’t tell then what they want to hear they will just find some one that will, and to satisfy USPAP you have to make it look official. My advice is quite while you are ahead.
 
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Anonymous

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<<It is probably not what you want to hear, but in my opinion there is no appraisal solution to this problem. You can’t measure any value factor that is not bracketed by sale data because if you do you are extrapolating. The sales have to bracket the subject not just in size and price but also in all major value influencing factors.>>

I have no problem with extrapolation. USPAP does not require that we bracket sales. If we were forced to do so, then the most expensive property in any given market becomes unappraisable. No property right is unappraisable..period. The key here is that using anything much smaller changes the market.

There are solutions. Change the definition of "Market Value" (not an option in a lending situation.) another is simply use an appraiser from "over there." Works every time. Since such property suffers no functional ob. in that market, they will use comps from that area, and never even know (because they never take the time to try and learn) the nuances of the local market. Everybody happy until this joker moves to California and trys to sell out. 3 years later his son-in-law is living there still trying to get the appraised price out of it. This is the situation with the Pilot's home. He has that much in it (500K) but neglects to mention his fancy lighted brick bridge (we're talking 50' or more) has washed out 3 times in 5-6 years. Cost? over $50K in the bridge originally. And he is not only across from a cemetery, he found an abandoned cemetery on the property.

I did find a 3500 SF home on 40 ac. that sold for $235,000 that had been on the market for 3 yr. for $325,000. Bad func. obsolescence [i.e.- only 2 bedroom and windows that were not designed to open, very dark place, owner was murdered but not in the house] and location (even more remote than the one I mention) I am simply going to have to extract an obsolescence from the market with smaller but functionally defective newer homes and apply it to the subject.
 
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Anonymous

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<<I don’t see why you want to get into some arcane argument about what form of obsolescence to call the screw up>>

I don't. But when I pay good cash for appraisal classes, I expect the instructor and provider to provide answers. After all, they called it Oddball and non-conforming appraisal class, not me. And giving them credit, we wooled this problem around one-half hour or more.

And this property is non-conforming..big time. It also points out a weakness in USPAP. USPAP states in 1-1 we must be "aware of, understand, and correctly employ those recognized methods and techniques".....to produce credible results. Right. Is USPAP saying some properties cannot be appraised. Bullfeathers. But the jury is still out on the best way to produce a credible result if we cannot agree what the best method to appraise this is. And if we cannot be for sure whether we are dealing with functional or external obsolescence, then how can we analyze our sales data correctly?
 

Austin

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Certified General Appraiser
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Virginia
Terrell: “It also points out a weakness in USPAP. USPAP states in 1-1 we must be "aware of, understand, and correctly employ those recognized methods and techniques".....to produce credible results. Right. Is USPAP saying some properties cannot be appraised? Bullfeathers.”

Reply: Yes, USPAP is saying by implication that some properties cannot be appraised. How can you achieve credible results by using a technique (extrapolation) that is known not to produce credible results? How can you correctly employ a technique when that technique by its very definition means it is out of the range of reasonableness because it is one of a kind? You can’t blame McKissock for not being able to answer the unanswerable. Read standard 1-1, a, b, & c. You could sum it all up by saying: “Don’t extrapolate.” You may have heard me use this example of extrapolating before, but it makes the point: If you extrapolate the trend line for weight gain for my 6-week-old grandson, by the time he is 21 years old he will weigh 172,000,000,000 pounds. I arrived at that number by employing a recognized technique that I fully understand. The problem is, it ain’t credible.
 

KD247

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California
Austin,

Why don't you think this property can be bracketed?

There are superior properties (similar improvement, superior location) in Rogers and Bentonville. There are inferior properties (similar location, inferior improvements) in Gentry.

The estimated value can be approached from at least two directions... 1)How much of a discount does a Rogers-Bentonville buyer wants for the inferior location? 2) How much of a premium will a Gentry buyer pay for the larger home?

Then there's the new construction data. Between 5 and 10 other owners paid X amount to build similar homes in similar locations. This data probably shouldn't be ignored.

Once the value range is established, you could consider the myriad of opinions, data, and interviews in placing the estimated value within that range. Isn't this pretty much the procedure for almost every appraisal?

We're comfortable doing this when the value range is something like $255,000 - $275,000. This job is just a bit tougher because the value range is probably about $350,000 to $450,000.
 

jtrotta

Senior Member
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Jan 16, 2002
Have to agree with Koert;

but what everyone has failed to realize, is that the person that created the example, "underpriced" his cost to create the work required to do the appraisal and this definietly wasn't a $275 appraisal.

secondly, you noted that a Banker lives there, why would he buy in an area that an appraisal can't be done???

How long has the builder been building in this area?? How has he priced the previous dwellings in that area?? There are many other factors that could be & should be reviewed before, the conclusion that "it can't be done" is uttered; there are some jobs that require extensive research and therefore, they need to be priced appropriately.

Good Luck 8)
 

Jo Ann Meyer Stratton

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Arizona
In my county we have the Gentry situation without the Bentonville-Rogers situation for 150 to 200 miles. The county's per capita income is about $24,000. Any house listed for over $100,000 takes months, months, and more months to sell. Then we have a few people who have are building mansions, spending from over $500,000 to over a million on construction, landscaping, etc. Next door are $60,000 tract homes and manufactured homes. There has been one sale of a million dollars, was on the market for 10 years, had 360 acres, wild life sancturary and sold to a monastary. Three years ago a home sold for $250,000 after being on the market for five years. Last year a home sold for $275,000 after three months marketing. And a few months ago one sold for $325,000 after one month! Everything else in the county in the past ten years has sold for less than $150,000. So each time I do an appraisal of a custom built home, I state marketing time could be 30 days to five years, and typically the value is half or even less than half of the costs. After all, I only have three sales to utilize regardless of home size, site area, location within the county regardless of school district, etc. One of the expensive homes bought 30 acres for $30,000. Another one bought seven acres for $100,000. A typical site that could range from 10,000 square feet to five acres ranges in sales price from $12,000 to $20,000; which is the upper limit for a site regardless of size. There are a batch of new expensive homes being built since the land is cheap and they can build their personal tasts and choices---but no expensive homes are reselling except the three listed above. So I have very large adjustments and lots of explanation and so far haven't gotten any arguments from anyone. After all, the lender will be making the loan based on income not the value of the property because if they base it on the property they will have a white elephant in inventory for at least five years! And my appraisal report tells them that!
 

Austin

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Jan 16, 2002
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State
Virginia
Koert: The way I see this problem, the question boils down to how much obsolescence, whatever kind you want to call it, is in the subject dwelling. The cause of the obsolescence is the market characteristics or market players in the subject market. When you use statistical thinking you base your actions on probability. That is why the definition of market value specifically asks for “most probable price.” That is another reason that USPAP precludes appraising some properties. In this instance, the benchmark or bracket necessary to measure the obsolescence in the subject property does not exist within the subject district. Just because the data exists outside the subject market is begging the question. For example, if my county has a person that is 9 feet tall, can the adjoining county with 1/10th the population assume they have a person 9 feet tall too? There two answers: 1. First of all, we are dealing with a freak or one of a kind situation, so the probability is extremely small that this can happen even once. 2. The probability of this happening is further lowered by the fact that the population in the area you are projecting into is only 1/10th the population of the study area. So if you answer this question by saying: “Yes the smaller county can have a person 9 feet tall with a high enough degree of probability that I will bet $200,000 of my clients money on it.”
When you state that other expensive dwellings have been constructed in the subject’s district, you are faced with the problem of saying cost equals market price. If that were the case we wouldn’t have this problem in the first place. In a situation as unique as this one, I would not put any faith in interviews with Realtors or anybody else. If Realtors knew anything we wouldn’t need appraisers. That is like the doctor asking the patient what kind of medicine to prescribe.
It all boils down to a probability problem. Will the data answer this question for the client: “Can you Mr. appraiser tell me with a high degree of probability what the subject property will sell for within x time period with sufficient accuracy to protect my investment?” The correct answer has to be; no I can’t because I can’t find even one market transaction of a resale in this market for that price-level dwelling. The subject might sell for a million dollars, but that is not highly probable. The question is “What is the most probable price” and to estimate most probable price you have to have enough statistically significant data for the calculation. An instance of one occurrence of an event is not science for the simple reason that an occurrence of 1 means the occurrence is not probable. That is another reason I like regression. With regression we can say:” there is a 95% probability that the actual price will fall within plus or minus $5,000 of the report price.”
If this appraisal did not involve money, for example, this was for a foundation to establish a tax basis or something similar, you could use the depreciated cost and do no harm by calling it a unique property or fake an extrapolation, but when money is involved and you give an opinion of price you owe it to your client to make sure the probability is balanced with the exposure level. Especially when the taxpayer is paying for the mistake. Put this case in perspective. You go out and bust your butt day in and day out to justify some $3,000 adjustment on a $60,000 dwelling, then in this instance you are willing to use methods with such a low degree of probability of support that you can’t report a probability level sufficient to support a price within a $100,000 range.
 
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