Being functionally obsolete can happen in all walks of life. A few examples would be a payphone, a heavy-tube television, and a cassette tape.
At one time these things were useful but now have been replaced by better new technology. Their economic life has come to an end.
If you are considering investing in property, you might have stumbled across the phrase functional obsolescence. When making a property investment, it’s a situation you’ll want to avoid to ensure you stay profitable.
While you might have heard this phrase used in other industries, what does functional obsolescence in real estate mean?
Let’s take a deep dive into the meaning as it applies to real estate. Not understanding obsolescence when purchasing a home could lead to a buying mistake you’ll regret.
Functional Obsolescence in Real Estate Explained
Functional obsolescence is a term that has been applied to many different sectors, often used to refer to technology that is out of date. With newer versions of tech devices eventually leaving older models functionally obsolete.
But in real estate, it is when a home doesn’t meet market expectations on a functional level. A feature of the home might be outdated and not easily improved. This reduces the desirability of the property and, in turn, its value.
Those in the real estate industry consider this to be the definition of functional obsolescence. The impairment of the functional capacity of a property leads to a loss of value as prospective buyers see a lack of utility.
This is important when investing in property as it means a big difference to your bottom line. Whether you are renting out the property or renovating and flipping, this is something you have to consider.
When homes are constructed that do not meet recognized utility, they suffer in the real estate marketplace. Features that are considered not practical or desirable end up turning away home buyers.
What Could Make a Property Functionally Obsolete?
To better understand functional obsolescence in real estate, let’s take a look at some common examples.
An Unfunctional Floor Plan
One of the worst kinds of functional obsolescence in real estate is an undesirable floor plan. A functionally obsolete floor plan can make a home harder to sell by shrinking the buyer pool. Supply and demand are one of the most significant factors in real estate market value.
When a floor plan is seen as undesirable, it deters home buyers from making an offer. Some examples of functional obsolescence when it comes to floor plans would be the following:
- Walking through a formal dining room to get to your master bedroom suite. Obviously, a poor architectural design was not thought through carefully.
- Having to walk through one bedroom to get to another.
- The home’s laundry room is located inside a secondary bedroom. This is another feature that would be considered a poor design.
- Having the bedrooms on one level of the home and the only bathroom is located on another level.
- When a home has a low ceiling height which is commonly found in older homes.
A lousy floor plan is one of the worst forms of functional obsolescence because oftentimes, the drawbacks can’t be changed. An outdated design feature is not uncommon at all in an old house. A good example is having a bunch of small choppy rooms. It is a type of obsolescence that is quite common.
While learning about the history of a house can be a cool thing to research, it can be costly if you overlook obsolescence.
Market tastes are constantly shifting, so it is not unexpected that a property built a few hundred years ago would have some functional obsolescence.
If there are too many bedrooms packed into not enough space, the home could be functionally obsolete.
For example, if a property is under 1,000 square feet but has three bedrooms, these rooms could be considered too small. While they can still technically be used as bedrooms, they wouldn’t offer enough room for most people.
The space in a home not being proportionately sound is a good example of physical obsolescence.
A Lack of Bathrooms
If a 4 or 5 bedroom property only has a single bathroom, the home will be far from ideal. Potential buyers or renters of a property like that are likely to be using most or all of the bedrooms.
Most home purchasers will expect and need more than just one bathroom, and because of that, potential buyers or tenants will keep searching.
Lack of bathrooms is an obsolete feature found in many antique homes built centuries ago. Adding an additional bathroom is one of the best ways of curring functional obsolescence in some older homes.
Market standards today call for larger homes to have multiple bathrooms, including an ensuite bath.
If a home hasn’t been very well maintained, it can also be functionally obsolete. If the standard of upkeep in the neighborhood is good, a property that has missed out on repairs and upgrades will certainly stand out, but not in a good way.
A home in good condition, on the other hand, blends in with the rest of the properties.
With more desirable options, homes that haven’t been maintained as they should be will normally be overlooked and less desirable to buyers.
Physical obsolescence can lead to a decline in a property’s value due to gross mismanagement of expected normal maintenance.
External factors can easily lead to a loss of property value. Undesirable design features outside a home can certainly lead to the loss of a property’s desirability.
When a property owner does not keep up with the maintenance of their home, it could lead to physical deterioration. This kind of external obsolescence would lead to another form of depreciation.
Other external factors that can influence the functional obsolescence of a subject property include noise pollution such as freeway noise and soaring crime rates.
If the traffic has increased on the street, it will make the property less desirable. It will make it more difficult for the resident of the home to use their driveway, but it will also put off families from buying or renting.
Busy roads and children don’t mix well, so families will be less willing to move in. The same can be said for having a significant amount of crime in a city or town. External obsolescence such as this will cause market demand to fall.
These are all items that should be researched thoroughly during the due diligence period. Due diligence in real estate is exceptionally important in order to make a sound buying decision.
Here are some other things that will lower a property’s market value.
The Four Different Types of Functional Obsolescence
There isn’t simply one type of functional obsolescence. These factors can be divided into three different categories.
The type of functional obsolescence that applies to the property can be the difference between something that can be dealt with or an investment set to lose your money.
Incurable Functional Obsolescence
Incurable obsolescence is often something that is completely out of the control of the homeowner. This could be something like a very busy road or the deterioration of the neighborhood.
While these are issues that can sometimes happen gradually when you own a property, they should be easy to see when looking to buy an investment home.
Though a home suffering from incurable obsolescence might appear to be a good bargain, that could be a mistake. You need to be aware that there is unlikely to be anything you can do to turn around the situation in some scenarios.
There can also be some obsolescences that could be cured but are either too expensive or impractical to fix. These situations can be more difficult to recognize as you might buy an investment property on the understanding that it needs certain repairs.
Only later discovering that the cost of those repairs is higher than expected, leaving you with a property that you will lose money on to renovate.
Curable Functional Obsolescence
The owner can cure many functional obsolescence situations. If, for example, the home hasn’t been well maintained for many years, this should be able to be fixed. The cost of the improvements, however, should be taken into consideration.
It would be best to be sure that you are clear on the costs involved and know the renovation expenses before you purchase. Contractor quotes should give you a more accurate understanding of the cost of repair involved in bringing the home back to the standard it should be.
Physical neglect and physical wear can at least be fixed.
It is possible to do too much to a property for the neighborhood it is located in. Doing so is what’s referred to as super adequacy. Superadequacy is a form of functional obsolescence caused by something associated with the property that exceeds market requirements but doesn’t add to the value vs. its cost.
For example, if you add a lavish swimming pool to a property that costs $200,000 due to extravagant features, it’s unlikely you would ever recoup your initial investment. You may receive some portion of the value, especially if you have an expensive home.
If you improve the property above the norm in the neighborhood, it could be challenging to make a profit or even get your money back.
The last type of functional obsolescence is economic in nature. Many people wonder about economic obsolescence and how it impacts the value of a property. What is economic obsolescence? It is when you lose value due to economic factors.
In real estate, it could be home values as a whole that are suffering due to market forces such as supply and demand. What is an example of economic obsolescence for a homeowner?
Economic obsolescence for just an individual property could be influenced by such things as an increase in crime rates, a busy highway added nearby, large powerlines, or some other undesirable improvement.
These are all considered common causes of economic obsolescence. If there are an unusual amount of buyers purchasing foreclosures surrounding the property, this could also be a form of economic obsolescence that could affect home values.
Likewise, if a development of low-income housing was added to a higher-end neighborhood this could be detrimental to home values. Buyers would not look favorably on low-income apartments being added to a luxury neighborhood.
Can a New Home Have Functional Obsolescence?
Yes, it is certainly possible. If you were buying new construction in a luxury neighborhood it would be expected all the homes would have similar features. If the builder decided to sell one of their lots, a buyer could certainly construct the home in a fashion that was obsolete.
For example, if a buyer installed Formica countertops in the kitchen and baths when all the other homes had stone, this would be a significant detraction. Imagine if this homeowner also put linoleum in all the bathrooms, carpet in the dining room, and had no wood moldings.
When the homeowner decided to sell their home it would already be functionally obsolete. Buyers would be expecting something completely different.
How Much of an Impact Does Functional Obsolescence Have?
When you get a real estate appraisal on the property, functional obsolescence can really become an issue. All situations are different, of course, but generally, curable obsolescence will be less of a problem than incurable.
There are numerous things real estate appraisers look at with an appraisal, and all types of obsolescence are one of them.
With super adequacy, it could lead to the investor not selling the home for enough to cover their investment costs. How much of a loss the investor might face will depend on the valuation from the appraiser.
This situation can be more of a problem if the appraiser uses comparative sales data, which is usually the case.
If you are in this scenario, it would be better for the appraiser to base the value on the replacement cost of the property instead. This will make more sense with super adequacy since there will not be other homes that offer comparable sales information.
You can see this situation occur quite a bit the best home in a neighborhood.
Real Estate Appraisers Will Discount Functional Obsolescence
Whether an appraiser uses the cost approach or the sales comparison approach if functional obsolescence exists, they will consider this when determining market value.
Appraisers will follow the Dictionary of Real Estate Appraisal, fifth edition for the definition of obsolescence.
Appraisers will use comparable properties and then make adjustments based on the severity. The types of obsolescence will be outlined in their appraisal report.
Whether you are a prospective homebuyer or a real estate investor growing your property portfolio, you need to understand and be alert to functional obsolescence. It could be the difference between a profitable investment or a mistake you’ll regret.
While no two investment properties are the same, obsolescence is something you should stay clear of. Knowledge of functional obsolescence is another tool in your arsenal to ensure your investments stay profitable.
Hopefully, you now have a much better understanding of what obsolete means.
About the author: The above Real Estate information on what is functional obsolescence is provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at firstname.lastname@example.org or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 34+ Years.
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