What is Economic Obsolescence?
Economic obsolescence refers to a decline in the value of an asset or collection of assets due to external factors. It impacts an asset like real estate because local market trends play a significant role in determining property values. Property values will respond if there is a change in the local or national economy because supply and demand determine prices. So, if demand decreases due to broader economic factors, property values will also decline.
Since economic obsolescence is due to external factors, it is typically incurable as there is nothing the property owner can do to fix the issue.
Economic Obsolescence Example
An example of economic obsolescence would be a local employer moving out of town. For example, let's say that Apple has a factory in a town where you own a rental property. If they shut the factory down and relocate their employees to another location, demand for local properties would drop. This would likely mean you cannot rent or sell your property for as much as before. As the factory closing is beyond your control, it's incurable, meaning there is nothing you can do, which is typical in cases of economic obsolescence.
How Does Economic Obsolescence Work?
Real estate does not exist in a vacuum, and it obtains its value from whatever buyers are willing to pay. Homebuyers not only base their purchasing decisions on the condition of the property itself but also take into consideration the location and broader economic conditions as well. So, if these conditions are deemed unfavorable, home values will also suffer.
A prime example is a real estate market crash. After the 2008 housing crisis, home values in some areas fell by 40-50%. Nothing fundamentally changed about the homes themselves, but broader market conditions made people trepidations about buying a home in certain areas, which impacted property values.
Common Causes of Economic Obsolescence
1. Changes in Aircraft Flight Patterns
One common example of economic obsolescence is a sudden change in airport flight patterns that causes noisy planes to fly over your home consistently. No one wants to be interrupted during dinner by the sound of a 747, so this would greatly impact the local property values.
2. Busy Highways
The construction of a new highway is another example of economic obsolescence. Busy streets bring noise and traffic that scares away homebuyers. Homes on busy roads near major highways tend to sell for less no matter the property's interior condition because buyers don't want the inconvenience.
3. Rise in Local Crime
Crime can also majorly impact property values. No one wants to live in a neighborhood where they don't feel safe, and buyers with the means tend to gravitate toward more peaceful areas. Plus, homeowners and investors want to feel confident that their homes will continue to appreciate, and a rise in crime indicates that values are likely to decrease.
4. Environmental Hazards
Environmental hazards are another external factor that impacts property values. If the city decides to construct a new landfill near your home or your neighborhood is suddenly in danger of penitential wildfires, it will inevitably impact property values. These environmental changes impact the quality of life in the area, which will repel potential buyers, leading to a slump in prices.
5. Loss of Jobs
High unemployment brought on by recessions and depressions can be another major cause of economic obsolescence. The property may be in good condition, but if buyers don't have the money to afford a loan, then prices will inevitably drop. This could occur at the national level if there is widespread economic stagnation or at the local level if a significant employer suddenly relocates or goes out of business.
6. Changes in Supply and Demand
Economic obsolescence could also occur if there's a change in local supply and demand. If there's an overabundance of housing in the area but not enough demand to fill them, it will lead to a decline in prices because scarcity keeps values high. Buyers will have more leverage, so sellers will have to drop their prices to compete.
7. Regulatory/Legislative Changes
Changes in local laws can also impact property values. For example, the zoning for the vacant lot next to your home suddenly changes from residential to commercial. It would have a major impact on property values because buyers may fear that they might open a shopping center or restaurant that would attract traffic and pests.
Functional Obsolescence vs. Economic Obsolescence
Functional and economic obsolescence are both forms of depreciation, but internal factors cause the former, and external factors cause the latter. Functional obsolescence occurs when the property is dilapidated, out-of-date, or otherwise undesirable. Economic obsolescence occurs when conditions in the broader economy or local area impact property values. Both lead to a decline in property values but feature distinct causes.
How Does Economic Obsolescence Affect Property Values?
Economic obsolescence hurts property values and causes them to decline. Unlike certain forms of functional obsolescence, economic obsolescence is typically incurable, which means there is nothing the homeowner can do to reverse the impact. So, if your home loses value due to economic obsolescence, you'll either have to accept the loss or hold onto the property and hope things turn around.
Economic Obsolescence Bottom Line
While it's essential to be aware of the factors that impact the value of your home, there isn't much you can do to prevent economic obsolescence. The best you can do is pay attention to trends in the local market and do extensive research when choosing an area to live. So, while you should consider the possibility of external factors impacting your home value, it isn't something you should stress about too much because it's mostly out of your control.