What Is Functional Obsolescence?
Functional obsolescence is a concept that refers to an object that has lost its value by becoming outdated or useless according to current market standards. This concept can be applied to any product or asset that holds value, including real estate. Functional obsolescence in real estate is when a particular property has a feature or condition that makes it less desirable to buyers, decreasing the market value.
How Does Functional Obsolescence Work?
Functional obsolescence results from market forces, especially the laws of supply and demand. In a free market, the value of a product or asset is determined by the laws of supply and demand. So, if the features of the object in question don’t keep pace with current trends, it will lead to a drop in demand. If there is no demand for said object in the market, its value will slowly drop until it is essentially worthless.
For instance, let’s assume you own an outdated house in a modern neighborhood. The more time goes on, the smaller and smaller the pool of potential buyers for the home will be until there is no one willing to purchase the property.
3 Types of Functional Obsolescence in Real Estate
- Incurable Functional Obsolescence
- Curable Functional Obsolescence
- Superadequacy
1. Incurable Functional Obsolescence
Incurable functional obsolescence occurs when the factors impacting the value of a property are beyond your control. For instance, if a busy shopping center is built next to the home, attracting traffic and rodents, it would make the house less desirable. You can’t just pick up the home and move it to a different location, so this form of functional obsolescence is considered incurable.
2. Curable Functional Obsolescence
Curable functional obsolescence occurs when the factors impacting the value of the property can be remedied through specific action. An example of curable functional obsolescence would be if the home’s value is affected by outdated features or physical deterioration inside or outside the property. These issues could be easily remedied through renovation or remodeling and therefore considered curable functional obsolescence.
3. Superadequacy
Superadequacy refers to when a homeowner unintentionally diminishes the value of a property by improving it too much. Say you installed an indoor sauna that ends up doubling your monthly utility bill. If the cost to heat and maintain the sauna outweighs the amount that it increases your property value, this is considered superadequacy. In this case, the addition would decrease the value of your home if you were to have it appraised, due to the added maintenance costs.
Examples of Functional Obsolescence
- External Factors
- Out of Place
- Poor Layout
- Physical Deterioration
External Factors
External factors can significantly impact the value of your home. An example would be if the city built a new highway in front of the property. The noise and traffic would likely scare away potential buyers, which will harm property values.
Out of Place
Sometimes, a home may lose value if it seems out of place in a particular neighborhood. For instance, the property is a townhouse in a neighborhood of all single-family homes. Even if the building is in good condition, there may be less demand because it feels out of place in the area, which will impact its value.
Poor Layout
A home could also be considered functionally obsolete if the layout is not considered desirable compared to the other homes in the neighborhood. An example would be if you had a 50’s style home with three bedrooms and one bathroom in an area full of modern four to five-bedroom homes with two bathrooms. That home could be considered functionally obsolete because it hasn’t kept up with the market’s current demands.
Physical Deterioration
Physical deterioration is another major contributing factor to functional obsolescence. A property in disrepair in the middle of an otherwise well-maintained neighborhood would be considered functionally obsolete. But, if the deterioration isn’t too extensive, it can be cured with a renovation.
How Does Functional Obsolescence Affect Property Values?
Functional obsolescence hurts property values, although how much will depend on the type and how much it impacts demand. For instance, a few outdated features like an old refrigerator or shag carpeting may only shave a few hundred or thousand dollars off the property’s market value and can easily be remedied. In contrast, years of deterioration or a sudden change in demographic trends could lead to a significant decline in values. But either way, functional obsolescence is a form of depreciation that will lead to a decrease in home values.
Functional Obsolescence Bottom Line
Functional obsolescence is a natural economic process that impacts the value of any product or asset that doesn’t keep pace with the tastes of modern consumers. While it’s important to understand that this concept also applies to real estate, as long as you maintain your home and pay attention to current market trends, it isn’t something you should worry about too much.