An appraiser is developing a cost approach for a 1958 ranch-style home. The original construction used balloon framing with 2×4 studs spaced 24 inches on center, no engineered floor joists, and a crawl space with minimal ventilation. Current market new construction uses platform framing, 2×6 studs at 16 inches on center, engineered I-joists, and conditioned crawl spaces. How should the appraiser treat these differences in the cost approach?
Correct Answer
A) Apply a percentage depreciation for functional obsolescence due to inferior design and materials.
Functional obsolescence arises from deficiencies or superadequacies in design, layout, or construction methods that reduce utility relative to current market standards. Balloon framing (fire-spread risk), wider stud spacing (reduced insulation and structural capacity), and unconditioned, poorly ventilated crawl spaces are recognized design deficiencies per Marshall & Swift and RS Means cost manuals—and are not correctable without full reconstruction. Thus, they represent incurable functional obsolescence, requiring a specific depreciation allowance separate from physical deterioration or external obsolescence. Option B is incorrect because effective age reflects overall condition, not specific design flaws. Option C misclassifies incurable obsolescence as curable physical deterioration. Option D incorrectly adjusts RCN rather than applying depreciation.
Why This Is the Correct Answer
Option A puts the defect in the correct bucket. Framing type, stud spacing, joist system, and crawl space design are all characteristics of how the improvement was designed and built rather than how it has worn, so they reduce utility relative to current market expectations and are measured as functional obsolescence. Because correcting them would require essentially rebuilding the structure, the obsolescence is incurable and is taken as a depreciation allowance. The amount should be supported by paired sales or by capitalizing the rent or price penalty the market actually imposes, not by the cost of the missing feature.
Why the Other Options Are Wrong
Option B: Exclude them from analysis—they are inherent in age-related depreciation and already captured in effective age.
Effective age and the age-life method capture overall condition as the market perceives it; they do not automatically absorb a specific design deficiency. Folding everything into age also removes any obligation to test whether the market truly penalizes these features, which is where support for the deduction has to come from. A defect that can be identified and measured separately should be.
Option C: Treat them as curable physical deterioration since they can be remedied during renovation.
Curable physical deterioration is deferred maintenance, items like a worn roof cover or peeling paint, where the money spent returns at least as much value. Framing systems and joist spacing are neither maintenance items nor economically remediable, so this option misclassifies both the cause and the cure test.
Option D: Adjust the reproduction cost new downward to reflect modern standards, then add a premium for outdated methods.
This option double counts and then contradicts itself. Reducing reproduction cost new to modern standards is essentially the definition of replacement cost, and adding a premium for outdated methods reverses the adjustment just made. The cost approach handles obsolescence through the depreciation deduction, not by editing cost new twice in opposite directions.
Inside, Outside, Worn Out
Three questions in order. Is it worn out? Physical. Is it inside the lot lines but poorly designed or built? Functional. Does it come from outside the lot lines? External. Then ask whether spending the money pays for itself; if not, the item is incurable.
How to use: For any depreciation classification item, name the cause first and the cure second. The standard distractors assign the right cure to the wrong cause, such as calling a design flaw curable maintenance.
Exam Tip
Check which cost the stem gave you. Under reproduction cost new, obsolescence from outdated components is still inside the number and must be deducted; under replacement cost, part of it is already gone.
Common Mistakes to Avoid
- -Deducting a cost to cure for an item the market will not pay to fix
- -Double counting a defect in both effective age and a separate obsolescence line
- -Confusing replacement cost with reproduction cost and deducting obsolescence twice
Concept Deep Dive
Analysis
Depreciation in the cost approach has three buckets and the exam wants the defect sorted into the right one. Physical deterioration is wear and tear from age and use, functional obsolescence is a loss in utility caused by something inside the property lines such as design, layout, materials, or construction method, and external obsolescence originates outside the property lines. Construction methods a current buyer would view as inferior, and that cannot be changed short of rebuilding, are incurable functional obsolescence: the cause is design rather than wear, and the cure costs more than the value it would add. Placement matters because reproduction cost new reproduces the outdated component, leaving the obsolescence inside the cost figure where it must be deducted as depreciation.
Background Knowledge
You need the three categories of depreciation and the curable versus incurable test, which turns on whether the cost to cure is recovered in value. You also need the difference between reproduction cost, a replica including outdated features, and replacement cost, a building of equivalent utility using current methods, because that choice determines how much functional obsolescence remains to be deducted.
Real-World Application
Valuing an older house with a two-bedroom, one-bath layout in a market that expects two baths, the appraiser measures the penalty from paired sales rather than from the construction cost of adding a bath, because the market discount, not the contractor's bill, measures incurable functional obsolescence.
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