An industrial property sits beside a river historically used for barge traffic. A new federal regulation bans commercial navigation on the river, eliminating the subject’s water-access advantage. The appraiser estimates the property’s land value — using sales of comparable industrial sites *with water access* — at $1,200,000. The improvement’s replacement cost new is $3,800,000, with physical depreciation of $570,000 and functional obsolescence of $220,000. Market data indicate water-access sites sell for a 15% premium over non-water-access comparables. What is the appropriate treatment of the external obsolescence arising from the navigation ban?
Correct Answer
D) Deduct the 15% reduction from the land value, since the land value estimate was derived from water-access sales and thus overstates value in the new regulatory environment.
The land value estimate of $1,200,000 is based on sales of *comparable sites with water access* — but the subject no longer has functional water access due to the regulation. Per USPAP Standards Rule 1-4(b), the appraiser must reflect all relevant characteristics affecting value. Since the land value estimate fails to account for the loss of navigability, it is overstated. The appropriate correction is to adjust the land value downward to reflect the absence of water access — i.e., derive land value from non-water-access industrial land sales, or apply a market-supported discount (here, 15%) to the $1,200,000 estimate. External obsolescence is not assigned to improvements because the improvements’ utility wasn’t impaired by the ban — they were built for industrial use regardless of water access; the *land’s* attribute changed. Thus, the externality directly affects land value. Option D is correct. Option A is incorrect because applying 15% to land alone presumes the land value estimate is correct — but it isn’t. Option C misattributes the loss to improvements. Option B violates USPAP by allocating external obsolescence between land and improvements.
Why This Is the Correct Answer
Option D identifies the actual defect, which is that the land value estimate was extracted from comparables carrying an amenity the subject has lost, and it prescribes the fix at the point where the error entered the analysis. Because the site value opinion must reflect the site's condition and legal circumstances on the effective date, the correction belongs inside the site valuation step. The 15 percent differential is market-derived from paired water-access and non-water-access industrial land, so applying it to the $1,200,000 produces a site value consistent with the post-regulation market. This also keeps the improvement depreciation clean, since none of the three forms of accrued depreciation applies to a change that affected only the site's attributes.
Why the Other Options Are Wrong
Option A: Apply the 15% reduction to the land value only, because the land is the sole beneficiary of water access.
The arithmetic this option produces is close to the right neighborhood, but its stated reasoning is the problem: it presumes the $1,200,000 land estimate is correct and then layers a separate 15 percent obsolescence deduction on top of it. That double-counts the framing, because the estimate was never valid for a site without water access in the first place. Treating the loss as an add-on deduction rather than as a defective input also leaves the report describing a site value that does not match the site being appraised.
Option B: Apply the 15% reduction to the total property value (land + improvements), then allocate the loss proportionally.
Spreading the reduction across land and improvements together and then allocating it proportionally assigns part of the loss to buildings whose utility the ban did not touch. The improvements still serve industrial use as designed, so their contributory value has no navigation-related impairment to absorb. Blending the two components also destroys the separation between site value and improvement depreciation that gives the cost approach its structure.
Option C: Apply the 15% reduction to the improvement’s contributory value, because the external factor impairs the utility of the improvements.
This puts the loss on the improvements on the theory that the external factor impairs their utility, but the facts say otherwise: the buildings function exactly as before, and what changed is an attribute of the ground they sit on. External obsolescence is charged against improvements when an off-site condition reduces what the improvements contribute, which is not the situation here. Assigning it to the improvements would also leave a site value on the page that still reflects an amenity the subject does not have.
Fix It Where It Broke
Trace the bad number back to the step that produced it. If the comparables carried an amenity the subject lost, the land value step is where the error entered, so that is where it gets repaired. A deduction taken somewhere else leaves a wrong number sitting on the page.
How to use: When a stem tells you what the land comparables had, compare that against what the subject has. Any mismatch is a land value problem. Only charge external obsolescence to the improvements when the off-site condition actually reduces what the buildings contribute.
Exam Tip
Read how the land value was derived before deciding where a loss belongs. Cost approach questions often hide the answer in one clause describing the comparables rather than in the numbers.
Common Mistakes to Avoid
- -Charging every off-site cause to improvement depreciation because it is labeled external obsolescence
- -Accepting a land value figure without checking whether the comparables share the subject's current attributes
- -Applying a percentage adjustment to total property value when only one component is affected
Concept Deep Dive
Analysis
This item tests where a value loss from an off-site cause belongs inside the cost approach, and it turns on how the land value figure was derived rather than on the arithmetic. The cost approach is structured as site value, estimated separately at the site's own highest and best use, plus the depreciated value of the improvements, with accrued depreciation broken into physical deterioration, functional obsolescence, and external obsolescence. A site value opinion is supposed to reflect the site as it actually is on the effective date, so any characteristic the site has lost must show up in that estimate rather than being carried as a separate deduction elsewhere. In this problem the appraiser derived the $1,200,000 figure from sales of industrial sites that still have water access, a characteristic the subject no longer has, so the land value input is stale by construction. The correction is to fix the input at its source, either by re-deriving site value from non-water-access industrial land sales or by applying the market-supported 15 percent differential to the $1,200,000. The improvements are a separate question: they were built for industrial use and their physical and functional condition is unchanged by the navigation ban, so nothing about the ban belongs in their depreciation line.
Background Knowledge
You need the structure of the cost approach, which develops site value separately by an appropriate method and then deducts accrued depreciation from the cost of the improvements, with depreciation classified as physical, functional, or external. You must know that site value is estimated as of the effective date under current legal and physical conditions, so a comparable adjustment problem in the land analysis is corrected in the land analysis. You should also understand that external obsolescence can be locational or economic, that it is generally incurable, and that when the off-site cause affects the land itself the loss is normally captured in the site value estimate rather than charged against improvements.
Real-World Application
An appraiser valuing a riverside industrial plant after a navigation ban discovers that every land comparable in the file predates the rule and enjoyed barge access. Rather than adding an obsolescence line to the improvements, the appraiser re-derives site value from inland industrial land sales, cross-checks the result against the 15 percent paired-sale differential, and explains in the report why the earlier land comparables were no longer applicable.
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:
People Also Study
Real Estate Market
13.6% of exam
Property Description
11.8% of exam
Land or Site Valuation
4.5% of exam
Sales Comparison Approach
16.4% of exam
Income Approach
8.2% of exam