Functional Obsolescence Vs Economic Obsolescence In Real Estate; Comparison, Examples

Functional Obsolescence Vs Economic Obsolescence In Real Estate; Comparison, Examples

Functional Obsolescence Vs Economic Obsolescence In Real Estate; Comparison, Examples

In the world of real estate, understanding the factors that contribute to the depreciation of property value is crucial for making informed investment decisions. Two key concepts to grasp are functional obsolescence and economic obsolescence, which can have a significant impact on the market value of a property.

Economic obsolescence refers to the loss of value caused by external factors beyond the control of property owners. These factors can range from changes in aircraft flight patterns and the construction of busy highways to the rise in local crime, environmental hazards, and loss of jobs in an area.

On the other hand, functional obsolescence refers to a reduction in the usefulness of a property due to internal factors, except for physical deterioration. Buildings that are too big or lavish compared to others in the neighborhood or properties with outdated or inadequate features are examples of functional obsolescence.

Now, let’s dive deeper into the causes and examples of both economic obsolescence and functional obsolescence in real estate, and explore their impact on property value and investment opportunities.

Key Takeaways:

  • Economic obsolescence refers to the loss of property value caused by external factors.
  • Functional obsolescence refers to a reduction in property usefulness due to internal factors.
  • External factors of economic obsolescence include changes in flight patterns, busy highways, local crime, environmental hazards, and loss of jobs.
  • Examples of functional obsolescence include outdated or inadequate features and buildings that don’t align with the neighborhood’s standards.
  • Understanding these concepts is essential for assessing property value and making informed real estate investment decisions.

Causes of Economic Obsolescence in Real Estate

Economic obsolescence in real estate refers to the loss of property value caused by external factors beyond the control of property owners. These factors can significantly impact the market value of a real estate property, making it important to understand the causes of economic obsolescence. Here are some common factors contributing to economic obsolescence:

  1. Changes in aircraft flight patterns: Excessive noise from airplanes when flight patterns change can negatively impact property values. Homebuyers often seek quiet and peaceful neighborhoods, and the noise pollution caused by frequent aircraft activity can deter potential buyers and decrease property values.
  2. Busy highways: Construction of highways near residential properties can result in extra noise, traffic congestion, and air pollution, affecting the desirability and value of the properties. The constant sound of traffic and the potential health risks associated with air pollution are major deterrents for homebuyers.
  3. Rise in local crime: High crime rates can make a neighborhood less attractive to potential buyers, leading to decreased property values. Safety is a primary concern for homebuyers, and areas with high crime rates often face difficulties in selling properties at desirable prices.
  4. Environmental hazards: Construction of landfills or sewer lines can cause foul odors, noise, and health risks, making the area less desirable for residents and impacting property values. The presence of environmental hazards directly affects the quality of life and perceived value of properties in the vicinity.
  5. Loss of jobs: When a major industry in an area closes, it can lead to job losses and a decrease in property value as people struggle to afford housing. The economic downturn and lack of employment opportunities make homes less desirable, resulting in a decline in property values.

These external factors contribute to economic obsolescence by affecting the desirability and attractiveness of a real estate property. Understanding these causes is crucial for property owners and investors in evaluating the market value and potential return on investment.

Examples of Functional Obsolescence in Real Estate

Functional obsolescence in real estate refers to a reduction in the usefulness or desirability of a property due to factors within the property itself, but excluding physical deterioration. Here are some examples of functional obsolescence:

An outdated property feature, such as an old house with only one bathroom in a neighborhood where new homes have multiple bathrooms, can render the property functionally obsolete. Potential buyers may prefer homes with more bathrooms, impacting its market value.

Another form of functional obsolescence occurs when a property is overimproved. For instance, an oversized master bedroom that does not align with market preferences can make the property less attractive to buyers, affecting its overall utility and value.

Underimprovement is also a cause of functional obsolescence. For example, a property lacking certain features, like a sideyard or an inadequate number of bathrooms, may be considered functionally obsolete compared to other properties in the area.

Appraisal of functional obsolescence in real estate is subjective and considers factors such as outdated design features, market preferences, and the overall utility of the property. While functional obsolescence can be curable through improvements that add value, it can also be incurable if the cost of resolving the obsolescence outweighs the potential benefit to the property value.

Table of comparison:

Criteria Functional Obsolescence Economic Obsolescence
Definition A reduction in the functionality or usefulness of a property due to outdated design or features. A reduction in the property’s value due to external economic factors affecting the entire area.
Cause Internal factors related to the property itself, such as outdated design or inefficient layout. External factors beyond the property’s control, such as changes in the local economy or neighborhood.
Scope of Impact Typically affects a specific property or a type of property with outdated features. Affects the property’s value due to broader economic conditions in the surrounding area.
Corrective Actions Can be addressed through renovations, updates, or changes to improve functionality. Often requires external economic improvements or developments in the surrounding area.
Examples Outdated appliances, inefficient layout, lack of modern amenities. Decline in property value due to a nearby factory closure or economic downturn in the region.
Responsibility for Correction Usually the responsibility of the property owner. Often beyond the control of the property owner and requires external economic improvements.
Timing of Recognition Can be recognized and addressed during property assessments or appraisals. May become evident over time as economic conditions in the area change.
Market Factors Specific to the property and may not impact neighboring properties. Affects multiple properties in the area, potentially leading to widespread depreciation.
Investment Implications Property owners may need to invest in renovations or upgrades to maintain or increase value. Property value may decrease, affecting the return on investment for property owners.
Appraisal Considerations Appraisers consider the cost to cure functional obsolescence when determining property value. Economic obsolescence is factored into property valuation based on its impact on the entire area.
Mitigation Strategies Renovation, modernization, or adaptive reuse to address functional deficiencies. Collaborative efforts with local authorities or economic development initiatives to improve the overall area’s economic conditions.
Depreciation Impact May contribute to physical depreciation of the property. Contributes to external obsolescence, impacting the property’s overall value.
Legal Implications Often within the control of the property owner and subject to local building codes. May require collaboration with local authorities or participation in community development initiatives.

FAQ

What is economic obsolescence in real estate?

Economic obsolescence refers to the loss of value of a real estate property that is caused by factors external to the property. This depreciation is beyond the control of property owners.

What are some common causes of economic obsolescence?

Common causes include changes in aircraft flight patterns, construction of busy highways, rise in local crime, environmental hazards, and loss of jobs in an area.

What is functional obsolescence in real estate?

Functional obsolescence refers to a reduction in the usefulness of a property due to factors within it, except for physical deterioration. It can be curable or incurable, depending on the situation.

What are some examples of functional obsolescence?

Examples of functional obsolescence include buildings that are too big or lavish compared to others in the neighborhood, and properties with outdated or inadequate features.

Why is it important to understand the difference between functional and economic obsolescence?

Understanding the difference between functional obsolescence and economic obsolescence is important for assessing the value of a property in the real estate market.

How do changes in aircraft flight patterns impact property values?

Excessive noise from airplanes when flight patterns change can negatively impact property values.

How does the construction of busy highways affect property values?

Construction of highways near residential properties can result in extra noise, traffic congestion, and air pollution, affecting the desirability and value of the properties.

How does a rise in local crime impact property values?

High crime rates can make a neighborhood less attractive to potential buyers, leading to decreased property values.

What are some environmental hazards that can affect property values?

Construction of landfills or sewer lines can cause foul odors, noise, and health risks, making the area less desirable for residents and impacting property values.

How does the loss of jobs in an area affect property values?

When a major industry in an area closes, it can lead to job losses and a decrease in property value as people struggle to afford housing.

What are some examples of functional obsolescence in real estate properties?

An example of functional obsolescence is an old house with one bathroom in a neighborhood where new homes have at least three bathrooms. Buildings that are too big or lavish in a certain area can also be considered functionally obsolete as they don’t align with the standards of the neighborhood.

Can functional obsolescence be cured?

Functional obsolescence can be curable if the obsolescence can be resolved by making improvements that add value to the property. However, it can also be incurable if the cost of curing the obsolescence outweighs the potential value benefit.

What factors are considered when appraising functional obsolescence in real estate?

Appraisal of functional obsolescence in real estate is subjective and considers factors such as outdated design features, market preferences, and the overall utility of the property.

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