real estate
Economic obsolescence
An impairment of attractiveness or usable life resulting from factors external to the property, such as economic forces or environmental changes, that impact supply-demand dynamics in the market. This kind of impairment may occur when economic pressures or environmental changes. It is important to differentiate between the value loss that might result from a property's intrinsic physical degradation and the value loss that can result from economic obsolescence. Physical deterioration and functional obsolescence are both variables that are inherently associated with a property.
Understanding Economic Obsolescence in Real Estate
Economic obsolescence in real estate emerges when external factors, beyond a property owner's control, lead to a decline in the property's value. Unlike physical deterioration or functional obsolescence, economic obsolescence stems from circumstances beyond a property owner’s control, such as changes in market demand, local economy shifts, or alterations in zoning laws.
Causes of Economic Obsolescence
Several key factors contribute to economic obsolescence including:
- Zoning Changes: New zoning regulations can limit the types of activities or improvements that can be made on or near a property, potentially decreasing its attractiveness to investors or buyers.
- Market Conditions: Fluctuations in the real estate market can affect demand for certain types of properties. For example, an oversupply of commercial real estate might reduce the value of commercial properties in the area, something we saw increase greatly in the pandemic
- Local Economy: Downturns in the local economy can lead to decreased demand for real estate within the area, affecting both occupancy and cash flow for property owners.
- Additional Factors: Increased crime rates or changes in flight patterns that lead to noise pollution are examples of ways to create economic obsolescence.
Impact on Property Valuation and Real Estate Investments
Real estate appraisers consider economic obsolescence when determining the market value of a property, as it directly impacts profitability and asset values. For real estate investors, understanding and identifying signs of economic obsolescence is essential for making informed decisions about buying, selling, or holding real estate assets. It's also important that property management developing strategies to counteract potential losses due to external obsolescence.
Economic Obsolescence vs Functional and Physical Obsolescence
Educating yourself on the differences between economic obsolescence, functional obsolescence, and physical obsolescence will help build you into the savvy property owner or investor that you want to be.
- Economic Obsolescence: This form arises from external factors outside a property owner's control, impacting the value of a property. Economic obsolescence, often considered incurable, devalues properties due to diminished desirability in the real estate market, not just the subject property but potentially affecting an entire neighborhood or region.
- Functional Obsolescence: Occurs internally within a real property when its design, materials, or layout becomes outdated and less desirable compared to newer properties. This can include outmoded plumbing systems, outdated electrical systems, or an inefficient floor plan. Unlike economic obsolescence, some functional obsolescence is curable through renovation.
- Physical Obsolescence: Refers to the wear and tear that buildings experience over time, including physical deterioration and damage. Physical obsolescence can result from neglect, lack of maintenance, or natural aging of materials. Like functional obsolescence, physical deterioration can often be mitigated through repair.