Appraisers' Free Forum

Can anyone figure this out?

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Subject is a 3-plex apartment with no AC, in a market where AC is standard and expected. If it had been installed when the building was built, it would have cost $4,000 but the cost of retrofitting now is $4,900. Installing AC would allow the owner to raise rents a total of $60 per month. The GRM is 95, so the increase in property value would be ($60 x 95 or) $5,700.

Solve for the amount of obsolescence to be charged for the lack of air conditioning.

It seems that they are attempting to imply that the $5,700 is the obsolescence amount but there isn't enough information in the question to be sure - IMO.

$5,700 is not the "correct" answer.

If there isn't enough information, what is missing?

Since it's curable functional depreciation, the cost approach FO is $4,900 (cost to cure). The functional utility adjustment in the SCA would be $5,700 (market reaction). (Assuming an "as-is" fee simple MV is the purpose.) Nothing really to "solve" for.

Jim,
The course answer is $1,700.

I think one of the problems with analyzing this is that the amounts are so small.

You idea, subtracting for the cost of something that isn't there sounds like double dipping in the cost approach as I have seen it done. Wouldn't you have to put the AC system into the cost new and then subtract it out as missing?

Here is what I mean. In an otherwise perfect market where "normal" ones sell for $100,000, you would adjust comps down $5,700 to $94,300 to indicate subject's value. The cost approach for "normal" ones would also come in at $100,000, but that would include the cost of the AC system ($4,900 ignoring that install new might well have a lower cost than retrofit). So the cost approach for the obsolescent one, which has no AC system, would show $94,100 BEFORE adjusting for the lack of AC. If you then subtract another $4,900, your cost approach will come in at $89,200. Right?

Arrrgh! Mixing the two approaches pisses me off. But that's how it's done.

So if I'm doing the house As-is, why would I include central air in a house that doesn't have it? Using your example figures, my RCN would be $96,000, not $100,000. But you're correct (and so is the course) about the FO calculation. It's the difference between cost (new) and the market reaction. In this case, the market charges an extra $1,700 for the absence of central air. So that's all you'd deduct for FO in the CA. My value by the CA: $96,000 - $1,700 =$94,300.

Now, in the SCA, you said normal ones sell for $100K. So I'd have a heating/cooling adjustment of -$5,700 to a comp which had CH/CA. $100K-$5.7 K = $94.3K (Or you could confuse things and put it on the functional utility line.)

Or you could confuse things and put it on the functional utility line

What's a functional utility line?

So if I'm doing the house As-is, why would I include central air in a house that doesn't have it?

Don't ask me. I am still waiting for the "experts" to perfect cost approach theory myself.

I can tell you this. If you think $1,700 is correct, the number is based you having to "include central air in a house [3-plex] that doesn't have it." That is:
-Cost new of AC that the 3-plex doesn't have: $4,000
-Less "value of the loss" (term used by course) -$5,700
-Equals cost approach adjustment for CFO: -$1,700
Even if you "hide" the $4,000 as part of a side calucation, the effect of the adjustment is to add the $4,000 to the cost new.

My primary reason for asking is that I have never understood why curable obsolescence is a defect. Given two otherwise equal properties wouldn't you pay a little more for the one that gives you the oppurtunity to spend $10,000 to make $20,000 in return.

My primary reason for asking is that I have never understood why curable obsolescence is a defect. Given two otherwise equal properties wouldn't you pay a little more for the one that gives you the oppurtunity to spend $10,000 to make $20,000 in return.

I would, but many would not. I once had a colleague who remarked to me that one of the electrical receptacles in his house had popped, smoked, and broken, and that it was going to cost him $75 to have an electrician to repair it. This was a man who could operate a helicopter, and pass complex written tests on its systems. Yet he couldn't change a $1.25 receptacle himself.

It boils down to one's ability to recognize the economy to be realized. Some can, but most cannot. Take a repaired water leak that caused a hole in the ceiling in a REO for example. Many buyers would look at it and say, "Damn! A hole in the ceiling. I'm sure not going to pay much for this thing, if I buy it at all." Women like Lee Ann or Rhonda would look at it and say, "Hmmmm. Couple of bucks worth of sheet rock and a schmear of drywall pooky, and that's fixed. No problem." Some see it as either incurable or horribly expensive, and others know the answer.

Jim Plante wrote: I would, but many would not. I once had a colleague who remarked to me that one of the electrical receptacles in his house had popped, smoked, and broken, and that it was going to cost him $75 to have an electrician to repair it. This was a man who could operate a helicopter, and pass complex written tests on its systems. Yet he couldn't change a $1.25 receptacle himself.

I totally understand. I'm married to one of those who would not know how to change the $1.25 receptacle. No joke. It is very irritating at times. How on earth a man lives to be in his mid 50s and can't fix anything is baffling to me.

But I guess it is good for repairmen. They have to make a living too.

I would, but many would not.

The subject is an apartment building. What percentage of investors in apartment buildings, in say southern Arizona, would fail to notice that the buidling under consideration has no A/C?

What if we don't devolve into speculative mass psychoanalysis? The last substantive thread I remember was size adjustments. One poster eschewed adjusting for small differences because the market can't see them. On Skippy's appraisals, apprarently, the market can't see neighborhood boundaries. I'll accept the slings and arrows that come along with being the resident curmudgeon who doesn't think declaring the market blind when convenient addresses the issue of whether, in a given approach, an adjustment should be upward or downward.

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As a side issue, I'd like to address the question of why one would estimate the cost of non existing components.

I have more questions than answers on the cost approach and market value. I used to post that the primary practical problem is not that cost isn't value. It's that cost often isn't even cost. Even texts say replacement or reproduction. So, there are multiple cost premises for the type of cost, but there are also multiple premises of what property components ought to be included or excluded (and which land).

Another practical problem I see is that appraisers do not declare one of their basic assumptions. It seems to me that the cost approach uses the hypothesis that if a site were developed to its "exact" HBU with new improvements in a "normal" market, cost would equal value. When the conditions in that hypothesis are not true, the appraiser charges a penalty against cost called depreciation.

The reasons that declaring the hypothesis openly in the report is important. In this disucssion, it not important just because USPAP seems to require it; but that seeing the declaration would help keep the appraisers feet on the same path he or she set out. So, it seems to me that if an appraiser is going to charge depreciation because subject failed to meet the hypothetical standard of perfection, the cost against which that depreciation is charged has to be the cost of perfection. Otherwise, the whole methodology is nonsense. Right? And as this question shows, the answer to how much to charge for depreciation in the CA, has to include knowing whether the item in question was included in the cost estimate or not. (Is that what you meant by something missing, Otis?)

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FWIW, the question was forwarded to me. My answer was based on the same idea I posted re the cost approach, often with appraisers cost is not really cost. That is why I would never trust an appraiser's market value answer that was based on cost. That is a contractor might want $4,900 to retrofit the AC, but what about the lost rents during the construction process. If a lease runs through the end of the year, the rent is not going up for a while. The owner might also have to allow some concessions for inconvenience to the tenants during the construction period.

I answered further that a real investor would probably not make any decision based overall value, but on rental value. I'd take $60/month times 12 is $720, the 720/4,900 is 14.6% max return. Start accounting for those tenant inconveniences and delays, and I'd say this obsolescence is not "curable." Fourteen percent is too low to be taking on a "fixer upper" or to fix something. I'd test curability (ie feasibility) for the fixer-upper portion, against fixer-upper cap rates (GRMs, whatever).

That is why I would never trust an appraiser's market value answer that was based on cost.

Never say never. For unique properties, a potential buyer has two choices:

1) He can buy the only one in existence. What's that going to cost? I'll bet it costs him what it cost the other guy to build, plus land, plus hassle factor (a.k.a. entrepreneurial profit.)
...or...
2) He can buy nearby land and build a new one. We can figure out what that will cost.

So, MV is the most probable transaction price. In this case, cost is the only price available--either from the original builder, or the builder of a new structure. Ergo, it follows that, in this particular example, cost IS market value.

It takes only one pinprick to burst the "never" balloon.

But for other than new or nearly-new properties in a normally active market, the CA is not an independent approach, and is at best a specious indicator of some sort of price. I agree with you that it should not be relied upon as an indicator of MV in most cases. That would be practically ALL cases wherein there are adequate comparables for the SCA and IA.

It takes only one pinprick to burst the "never" balloon.

I said I would never trust one. You can trust them all you want with your money.

FWIW, I have never seen a version of the "unique" argument made sharp enough to burst a ballon. First, to play your game, every real property is "unique." Second, even if the user or investor has no other option to buying subject than building whatever it is they really want or need, what makes you think a buyer would use a pricing process based on the cost of the white elephant, rather than the cost to build what they really want or need? Another way of asking this, is how can subject be it's own substitute?

For example, let's say you estimate the RCN of your oddball, based on it's own land value, just like appraiser's reflexively do, and it comes up $1 mil. Now imagine that someone create the "average" size shell space for $400,000. Is the offer from this prospective buyer going to change if the cost of the white elephant is instead $1.1 million, or $1.2 million or $1.3 million? Which cost gives you a getter idea of a likely selling price: the white elephant or the generic shell space?

Oh BTW, the course gives a universal obsolescence formula. (It may just be me, but I don't understand the idea of a formula that has an "or" in it. That's two formulas).

1. Cost of existing item
2. Less depreciation previously charged
3. Plus cost to cure (all costs) OR value of the loss
4. Less cost if installed new
5. Equals depreciation for functional obsolescence

That's a Boolean "OR", so it works. In Excel:
= COST - DEPR + IF(C2C > 0, C2C, LOSS ) - COSTNEW
...assuming you've named the cells appropriately.

And my argument assumes that the buyer wants exactly the unique property, and not something almost like it, or a suitable shell, or anything else. It's not a very likely scenario, but it could happen.

That's a Boolean "OR", so it works. In Excel:

I don't think it has anything to do with programming. I take it to mean the bulk of the obsolescence can be either the "value" of the loss, or the cost to cure.

That is, according to the (TAF approved) course,
if you use value of the loss, the CFO charge is: $5,700 less $4,000, or $1,700
if you use the cost to cure, the CFO charge is: $4,900 less $4,000, or $900

Part of the genesis of the "or" is what I see as a general willy-nilly tendency of appraisers to use cost and call it value, when value is hard to calculate.

The AI text (at least the most recent version I have) identifies three types of CFO. The course case study seems to fit the one that says deficiency requiring "deficiency requiring modernization." The AI has the same formula as the course, except for the "or." The AI text says cost to cure (well, actually it says cost to remove plus cost to instal new feature). So, per the AI text, the depreciation charge is the other "or," i.e., $900. FWIW, the AI, like this course, does not directly mention disruption of owner benefits or incentive as part of "cost."

Interestingly, the AI also defines FO as a loss of "value." However they calculate that by adding and subtracting one cost from another. I guess that makes them the source, when it comes to the willy-nilly calculating of cost and just calling it value.

I suspect you aware of my motivation here. After 20 years of doing this, I am no less impressed today than when I started at what I see is a unique capacity of the appraisal profession. Given the simplest problem, in clinical conditions, a few 'givens' on word problem that have to be taken to reflect perfect data a perfect market - that is, just three stinkin' pieces of information (numbers) - and the appraisal profession cannot produce a single, uniform answer.

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And my argument assumes that the buyer wants exactly the unique property

You might have mentioned that assumption up front, because you are now making it sound like this is something other than market value. Also, since my first post, I signed up and took the course in question on line. As part of my student reponse, I sent the criticism that the course failed to recognize the primary applicability of cost approaches is insurance decisons, use value and deprival value. It seems to me that deprival value is what you are getting close to here - what one person would pay who does not want to be "deprived" of the use of a specific property. This is generally based on cost new, and includes considerations other than "depreciation."