A house is being valued in a market where recent sales run far below replacement cost new less depreciation. This gap most likely signals:
Correct Answer
C) External obsolescence or a soft market the cost approach missed
Why this is correct: External obsolescence or a soft market the cost approach missed. The governing concept is reconciliation. When market value (from sales) is consistently below cost new less depreciation, the cost approach has likely understated depreciation, often in the form of external (economic) obsolescence due to a soft market. Why the other choices are wrong: A simple arithmetic error somewhere in the depreciation calculation is possible but not the "most likely" signal for a consistent market-wide gap. That cost new was estimated too low for the market is illogical; if cost were too low, it would be closer to or below market value, not above. That the land value estimate should be increased would widen the gap further, as a higher land value reduces the depreciated improvement value. Exam tip: A persistent gap where cost exceeds market value is a red flag for unaccounted external obsolescence.
Why This Is the Correct Answer
A persistent gap between market prices and cost less depreciation usually signals external obsolescence or a soft market that a cost estimate built from construction figures does not capture.
Why the Other Options Are Wrong
Option A: A simple arithmetic error somewhere in the depreciation calculation
A single arithmetic error would not produce a market-wide pattern. The gap appears across sales rather than in one calculation.
Option B: That cost new was estimated too low for the market
Cost estimated too low would push the cost indication below the sales, which is the opposite of what is observed.
Option D: That the land value estimate should be increased
Raising land value to close the gap adjusts an input to force agreement rather than explaining the divergence.
The Gap Is the Message
The Gap Is the Message. When the market disagrees with cost, the market is telling you something.
How to use: Investigate before adjusting. Forcing the numbers together destroys the information the divergence carried.
Exam Tip
Quantify the obsolescence from market evidence — paired sales or capitalized rent loss — rather than treating the gap itself as the measure.
Common Mistakes to Avoid
- -Adjusting inputs to force the approaches to agree
- -Attributing a market-wide pattern to a calculation error
- -Using the raw gap as the obsolescence figure without market support
Concept Deep Dive
Analysis
When sales run persistently below cost new less depreciation, the disagreement is usually real rather than arithmetic, and the message is that the cost approach has not captured everything the market is pricing. The most common explanation is external obsolescence: a declining employment base, an oversupplied market, a neighbourhood in transition, or some influence outside the property that buyers are discounting for and that a cost estimate built from construction figures never sees. A soft market produces the same signature — buyers can choose among many alternatives, so nobody pays reproduction cost for an existing building. The correct response is to investigate the gap and, where warranted, quantify the external obsolescence from market evidence such as paired sales or capitalized rent loss. What the appraiser should not do is reverse-engineer the inputs to close the gap: raising land value or claiming cost was understated makes the numbers agree while concealing the very information the disagreement was providing.
Background Knowledge
External obsolescence is a loss in value from influences outside the property, often market-wide. Where sales run below cost less depreciation, the gap frequently measures obsolescence the cost approach has not otherwise captured.
Real-World Application
An appraiser in a town losing its main employer finds sales 15 percent below cost less depreciation, investigates, and quantifies external obsolescence from paired sales.
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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