Contingency Fee, Client Pressure, and Functional Obsolescence
An appraiser is contacted by the owner of a 30,000-square-foot warehouse built in 1998. The owner wants an appraisal for a property tax appeal and offers a fee of 20% of any tax savings, plus a $2,500 base fee. During the site visit, the owner says, 'Everyone uses the cost approach to show functional obsolescence; just make sure the value comes in under $1.8 million.' The owner provides a contractor's estimate of $4.2 million replacement cost new, land value of $600,000, and claims the building has 25% physical deterioration and 15% functional obsolescence because the clear height is 24 feet while new warehouses have 32 feet. The appraiser's own market data show 32-foot clear-height warehouses lease for $0.10 per square foot more per year and sell at 6.5% cap rates; the subject leases for $7.25 per square foot. The appraiser must decide whether to accept the assignment, how to handle the fee, and what value the cost approach supports.
1. Identify the USPAP and ethical issues raised by the fee arrangement and the owner's instruction. What should the appraiser do?
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The 20% contingency fee is prohibited because compensation is contingent on the amount of value or the outcome of the appeal. The Ethics Rule requires that compensation not be contingent on the amount of value, the direction of value, or the occurrence of a subsequent event. The owner's instruction to 'make sure' value is under $1.8 million is client pressure and a threat to independence and objectivity.
The appraiser should decline the contingency, offer a fixed or hourly fee, and state in writing that the value will be developed independently. If the owner insists on a target, the appraiser should withdraw. The appraiser may accept the assignment only if the fee is not outcome-based and the scope of work is clear. The report should document the independence issue and the client's request.
2. Using the cost approach, calculate the indicated value. Show depreciation by components and explain whether the functional obsolescence claim is supported.
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Replacement cost new: $4,200,000
Physical deterioration: 25% × $4,200,000 = $1,050,000
Functional obsolescence: the owner claims 15%, or $630,000, but the market evidence does not support that figure. The rent difference between the subject and 32-foot clear warehouses is $0.10 per square foot per year. For 30,000 square feet, the annual loss is $3,000. Capitalized at 6.5%:
$3,000 ÷ 0.065 = $46,154
That is the income loss attributable to the height deficiency, not $630,000. Total depreciation = $1,050,000 + $46,154 = $1,096,154. Depreciated cost = $4,200,000 − $1,096,154 = $3,103,846. Add land of $600,000 = $3,703,846, or about $3.70 million.
The 15% functional obsolescence claim is unsupported by the rent and cap-rate evidence.
3. What should the appraisal report disclose, and what records must be retained?
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The report should disclose the intended use (tax appeal), the fee arrangement (fixed, not contingent), the owner's target request, and the fact that the appraiser did not adopt it. It should describe the cost approach, the source of the $4.2 million replacement cost, the 25% physical deterioration, and the market-derived functional obsolescence of about $46,000.
The report should state that the cost approach is one indication and should be reconciled with the sales and income approaches. Older warehouses often require heavier reliance on those approaches. The appraiser should retain the engagement letter, fee agreement, field notes, contractor estimate, rent comparables, cap-rate support, and correspondence for at least five years or the state's required period. The certification should confirm independence and objectivity.