A commercial property's value falls after a competing center opens nearby. This loss is:
Correct Answer
D) External obsolescence from competition
Why this is correct: External obsolescence is a loss in value caused by negative factors outside the property boundaries, such as economic changes or new competition. A new competing center is an external economic factor. Why the other choices are wrong: It is a form of depreciation (obsolescence). Functional obsolescence relates to the property's design or layout. Physical deterioration is wear and tear from use or age. Exam tip: External = caused by outside factors. Functional = caused by internal design flaws. Physical = caused by wear and tear.
Why This Is the Correct Answer
A competing center opening nearby is a force entirely outside the subject's boundaries that reduces the subject's income and therefore its value, which is the textbook definition of external obsolescence in its economic form. Nothing about the subject's own construction or design changed, so the loss cannot be physical or functional. It is incurable from the owner's standpoint because no expenditure on the subject removes the competitor. Appraisers typically measure it by capitalizing the rent loss or by paired sales analysis.
Why the Other Options Are Wrong
Option A: Not a form of depreciation at all
The loss plainly is depreciation. In appraisal usage depreciation means any loss in value from any cause, measured as the difference between cost new and current contributory value, and it expressly includes obsolescence as well as physical wear. This option trades on the accounting meaning of depreciation, which is a scheduled write-off of cost, but the appraisal meaning is broader.
Option B: Functional obsolescence of the layout
Functional obsolescence requires a flaw within the property, such as an awkward layout, an outdated floor plan, inadequate ceiling height, or an oversized component. The subject's layout is unchanged; only the competitive environment changed. Candidates pick this when they hear 'a center' and start thinking about retail design instead of asking where the cause sits.
Option C: Physical deterioration from reduced traffic
Physical deterioration is the loss from wear, tear, decay, and the elements acting on the structure. Reduced customer traffic does not physically wear anything out, and in fact less traffic means less physical wear. The option is a deliberately incoherent pairing that catches candidates who match on the word 'traffic' rather than reasoning about cause.
Inside, Outside, Worn Out
Three questions in order. Is the cause worn out? Physical. Is the cause inside the fence but badly designed or sized? Functional. Is the cause outside the fence and beyond the owner's control? External. Draw the property line on your scratch paper and put the cause on one side of it.
How to use: For any depreciation classification question, underline the cause named in the stem and ask only whether it sits inside or outside the property boundary. New competition, a closing plant, a new highway, and a neighboring landfill are all outside; a bad floor plan and an oversized mechanical plant are inside.
Exam Tip
External obsolescence is the answer whenever the stem describes something happening off the subject's site, and it is the only category the exam treats as reliably incurable.
Common Mistakes to Avoid
- -Reaching for functional obsolescence whenever the property type is commercial, without asking where the cause is located
- -Denying that market-driven value loss is depreciation because it is not physical wear
- -Treating external obsolescence as curable and deducting a cost to cure the owner cannot actually spend
Concept Deep Dive
Analysis
This question tests the three categories of depreciation and, specifically, the rule that tells you which one applies: where is the cause located? Physical deterioration comes from wear, tear, and the action of the elements on the improvements themselves. Functional obsolescence comes from a defect inside the property lines, in the design, layout, capacity, or equipment, and it can be a deficiency or a superadequacy. External obsolescence comes from something outside the property lines entirely, either economic, such as new competition or a soft employment market, or locational, such as a new highway or an adjacent nuisance. External obsolescence is the only one of the three that is essentially always incurable, because the owner has no control over the cause.
Background Knowledge
You need the three forms of depreciation and their causes, plus the boundary test for locating the cause inside or outside the property lines. You should also know that external obsolescence is generally incurable and is commonly measured by capitalized rent loss or by paired sales, and that it is often allocated between land and improvements.
Real-World Application
A neighborhood strip center loses two anchor tenants after a larger power center opens a mile away. The appraiser holds the building's condition and design constant, measures the rent decline against the pre-competition rent roll, capitalizes the shortfall, and reports it as external obsolescence in the cost approach.
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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