FUNCTIONAL OBSOLESCENCE IN REAL ESTATE
Obsolescence.- The value of property or structures become less by its becoming out of date in style, in structure in design, etc., and this is termed as Obsolescence. An old dated building with massive walls, arrangements of rooms not suited in present days and for similar reasons, becomes obsolete even if it is maintained in a very good condition, and its value become less due to obsolescence.
The obsolescence may be due to the reasons such as a progress in arts, changes in fashions, changes in planning ideas, new inventions, improvements in design technique, etc. A machine of old design may become obsolete, through it may be in good running conditions and its value will be less. Thus, though the property is physically sound, it may become functionally inadequate and its economical return becomes less. When considering a real estate purchase, it’s important to be mindful of how functional obsolescence may impact the market value of a property.
Functional Obsolescence (Real Estate):-
In real estate, functional obsolescence refers to the diminishing of the usefulness of an architecture design such that changing it to suit current real estate designs is almost impossible. In the long term, functional obsolescence results in losses to investors due to the fact that real estate investments are financially intense.
Investors in the functional obsolescence situation can consider the long-term usefulness of the property in question. For example, an old, two-bedroom house in an area with modern three bedrooms with a bathroom in each room can be considered functionally obsolete.
Other items that are highly prone to functional obsolescence include electronics, such as smartphones. The smartphone industry is constantly changing, and new designs become obsolete fast due to incompatibility and old designs.
However, sometimes, it is possible to make a comeback from functional obsolescence. For example, companies in the furniture industry can redesign their furniture to conform to the latest trends and present them for sale in modern designs.
Types of Functional Obsolescence
The two main types of functional obsolescence are:
1. Curable obsolescence
Curable obsolescence can be caused by a lack of specific fixtures that can be remedied by purchasing the required fixtures, the presence of a fixture that is no longer important to the property, or the lack of a fixture(s) that can be remedied by replacing the required item.
2. Incurable obsolescence
The incurable functional obsolescence is mostly caused by external factors that the property owner has no influence on. Investors can prevent the occurrence of such obsolescence by conducting proper research on the most recent trends and designs in real estate before committing to the investment.
Incurable obsolescence is a type of obsolescence that is not financially practical to cure. It occurs when it is too costly to fix the problem. For example, an old residential building in an area with modern residential houses can be considered incurable because it would require heavy renovations to make it modern and increase its resale value.
The cost of the renovations will be significantly higher than the amount it will bring back when sold. In general, functional obsolescence can be foreseen in the initial stages of the analysis and valuation of q real estate property before the acquisition.
Impact of functional obsolescence on property value:-
Ultimately, functional obsolescence becomes a problem when you’re talking about the appraisal. If the obsolescence is due to a deficiency, it will undoubtedly lead to a decline in the valuation of the property. Though, obviously, an incidence of curable functional obsolescence will not affect the property value as much as an incidence of incurable functional obsolescence.
On the other hand, in the case of a super adequacy, the investor will simply not be able to get enough money out of the investment to cover the cost of the improvements they made. Instead of making money on the investment as expected, the investor will probably have to take a loss on the property. Though how big of a loss will depend on the total cost of the improvements compared to the valuation that the property is given by the appraiser.
Often, if you have a property that is functionally obsolete, it’s best to ask the appraiser to use the cost approach to valuation rather than the sales comparison approach. Rather than trying to find comparable properties on the market, this approach will value the property based on the replacement cost of rebuilding the building from scratch.