A certified general appraiser is developing a cost approach for a 25-year-old office building located in a neighborhood where new zoning prohibits future office development and mandates residential conversion. The appraiser estimates the site’s highest and best use is now residential, and determines the land value — based on vacant residential land sales — is $850,000. The building’s replacement cost new is $2,100,000, with accumulated physical depreciation of $315,000 and functional obsolescence of $140,000. External obsolescence is present due to the zoning change. How should the appraiser treat external obsolescence in this scenario?
Correct Answer
B) Exclude external obsolescence entirely because the land value already reflects the zoning restriction.
Why this is correct: Site value in the cost approach is estimated as though vacant and available for development to its highest and best use. Here the appraiser took that value from sales of vacant residential land in the same rezoned area, so the $850,000 already reflects everything the zoning change did to the site. External obsolescence measures the loss in value caused by influences outside the property, and deducting it again from the improvements after it has already been captured in the land figure double-counts the same influence. With the building no longer supported by the site's highest and best use, its contributory value is what the market will pay for it, and the external influence is not charged twice. Why the other choices are wrong: 'Deduct external obsolescence from the improvement's depreciated cost, then add land value to arrive at indicated value' is the mechanical routine, but applying it here charges the zoning change once to the land and once to the improvements. 'Add external obsolescence to physical and functional depreciation in the calculation of accrued depreciation' has the same double-counting defect; accrued depreciation does include external obsolescence in the general case, but only where the land value has not already absorbed it. 'Treat the entire difference between the office building's contributory value and its residential land value as external obsolescence attributable to the improvements' compares two figures that measure different things and produces a number with no analytical meaning. Exam tip: Ask where the external influence was captured. If the site value already reflects it, deducting it again from the improvements charges the market for the same loss twice.
Why This Is the Correct Answer
Because the site value came from sales of vacant residential land under the same new zoning, those transactions were priced by buyers who already knew office use was prohibited. The external condition is therefore inside the $850,000 figure, not outside it waiting to be subtracted. Taking a second deduction for the zoning would double count the identical economic effect, which is the specific error the choice describes and rejects. With the office improvements no longer supporting highest and best use, the credible value indication is the land value as improved-to-be-converted, not land plus a separately penalized building.
Why the Other Options Are Wrong
Option A: Deduct external obsolescence from the improvement’s depreciated cost, then add land value to arrive at indicated value.
This is the mechanically standard cost approach sequence, which is why it looks safe, but applying it here subtracts the zoning penalty a second time after the land comparables already priced it in. The result would be a value indication below what a buyer of the vacant residential site would pay, which fails a simple reasonableness test. Correct method is worthless if it double counts the same market reaction.
Option C: Add external obsolescence to physical and functional depreciation in the calculation of accrued depreciation.
Accrued depreciation is conventionally the total of physical deterioration, functional obsolescence, and external obsolescence, so lumping them together is not always wrong as bookkeeping, but it is wrong as an answer here. The choice sidesteps the actual issue, which is whether the external loss should be recognized at all given how the site value was derived. Adding an amount you should not be deducting does not become correct by relabeling where it is added.
Option D: Treat the entire difference between the office building’s contributory value and its residential land value as external obsolescence attributable to the improvements.
This treats the gap between the office building's former contributory value and the residential land value as obsolescence belonging to the improvements, but a building that no longer supports highest and best use has no contributory value to erode in the first place. The loss shows up in the land, not as a measurable deduction against a structure that the market would ignore or demolish. It also risks producing an obsolescence figure larger than the improvements themselves, which is a sign the allocation is wrong.
Count It Once
Ask where the market already spoke. If the comparable that produced the land value was itself subject to the same external condition, the market already applied the penalty in that sale price, so you do not get to apply it again. One market reaction, one deduction.
How to use: Whenever a question pairs an external cause such as rezoning, a highway, or an airport with a land value derived from comparables under the same condition, look for the answer that avoids the second deduction. If the land value came from unaffected comparables instead, the external deduction is live and belongs in the calculation.
Exam Tip
Trace the source of the land value before deciding whether to deduct external obsolescence. The phrase based on vacant residential land sales in this item is not scenery, it is the fact that decides the answer.
Common Mistakes to Avoid
- -Running the cost approach mechanically without first confirming the improvements match highest and best use
- -Deducting external obsolescence from improvements when the land comparables already reflected the same external force
- -Forgetting that where improvements have no contributory value, demolition cost may reduce site value rather than increase the improvement deduction
Concept Deep Dive
Analysis
The cost approach is built as land value plus depreciated improvement cost, and it only produces a credible answer when the improvements are consistent with the site's highest and best use. Here the zoning change has moved highest and best use to residential, and the land value was drawn from vacant residential land sales, which means the price paid for comparable dirt already embeds the market's full reaction to the new zoning. The office improvements no longer support the highest and best use, so their contributory value collapses toward nothing, and the value of the property is essentially the value of the site. The trap in the item is that external obsolescence is real in the sense that an external force caused the loss, but the loss has already been captured once by the land comparables. Deducting it again from the improvements would subtract the same market reaction twice from a single value indication.
Background Knowledge
You need highest and best use as of the effective date, including the four tests of legally permissible, physically possible, financially feasible, and maximally productive, and the rule that site value in the cost approach is valued as though vacant and available for its highest and best use. You also need the three categories of depreciation and the understanding that external obsolescence can attach to the land, the improvements, or both.
Real-World Application
An appraiser handling a rezoned commercial strip finds every recent land sale is a builder buying for townhomes. She values the site from those sales, concludes the aging retail building is at or near the end of its economic life, discloses the demolition cost consideration, and reports the value as essentially site value rather than running a cost approach that penalizes the building twice.
More Cost Approach Questions
In a cost approach for a proposed building, the appropriate cost basis is generally:
A warehouse cost $210,000 to build when the cost index stood at 105. The index is now 210. Its indicated current cost is:
The age-life method expresses depreciation as:
Market extraction of depreciation is limited by the fact that it:
Functional obsolescence caused by a deficiency is measured as curable when:
Curable physical deterioration is measured at cost to cure because:
A 2,050 sq ft dwelling is priced at $178 per square foot with a $34,000 detached garage and $21,500 of site improvements. Cost new is:
A house has three bedrooms sharing one bathroom, and adding a second bath is economically justified. This is:
Direct costs in a construction budget include:
An appraiser writes that a 40-year-old house has an effective age of 10 but describes original wiring, original kitchen and a 25-year-old roof. The report's problem is:
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