Remember the first cell phone you had? Your first television? That payphone you used at the mall? These technologies have one thing in common. They’re all functionally obsolete. They’re outdated. Now, they have newer, redesigned, and better-operating replacements. They’re also likely worth less than what you once paid for them.
So, what does functional obsolescence have to do with real estate? Whether you're interested in becoming a real property appraiser, or you’re a savvy homeowner, it’s a useful term to know.
What is Functional Obsolescence?
Functional obsolescence in real estate refers to a loss of property value caused by an outdated design, inefficient technology, or poor condition. Real estate properties usually become functionally obsolete when there are changes in:
- Home technologies, utilities, and systems
- Lifestyle and interior design needs
- Market preferences and demand
If a home has a small kitchen, for instance, it could be considered functionally obsolete if the average square footage of kitchens in nearby homes has increased over time. As another example, a four-bedroom home with a single bathroom can be considered functionally obsolete. Why? In most real estate markets today, lifestyle changes and market demand support the need for more than one bathroom in a home.
It’s up to the real property appraiser to determine how much functionally obsolete features influence a home’s value.
Three Types of Functional Obsolescence – and Their Fixes
There are three types of functional obsolescence in real estate. Some may be more favorable than others in terms of appraised value and investment potential.
Incurable Functional Obsolescence
Incurable functional obsolescence means that the cause of the functional obsolescence can’t easily be fixed (if at all). The most common factors contributing to this type of functional obsolescence include external ones such as physical location, surrounding environment, social influences, and architectural design.
Here are a few examples of incurable functional obsolescence:
- A home that sits next to a noisy highway
- A home with a floor plan that requires you to walk through a bedroom to get to a main part of the house
- A smaller starter home with high-end luxury homes built around it
- A home located in an area where unemployment is high, and no change is predicted anytime soon
In these instances, it's nearly impossible or not economically feasible for the property owner to fix the issues.
Curable Functional Obsolescence
Curable functional obsolescence is a type of functional obsolescence that’s caused by physical deterioration or outdated design features in a property. This kind of obsolescence can be fixed relatively easily by the property owner. They would simply renovate and update the property.
Examples of curable functional obsolescence include:
- A home with an outdated kitchen
- A house with a sagging front porch
- A home with roof damage caused by normal wear and tear
In these cases, the property owner can make the renovations or repairs needed, and it will likely increase the value of the home.
Superadequacy
The tables are turned a little with superadequacy. This type of functional obsolescence could mean two things:
- A property is overdeveloped to the point that its resale value has been reduced.
- A feature was added to a property that did not ultimately contribute to its overall value.
Superadequacy happens sometimes in neighborhoods where one property has been updated extensively while the rest remain in their original condition. It can also happen when added home features don’t fulfill market preferences and demand.
Examples of superadequacy include:
- A home with an indoor swimming pool
- A home with a $60,000 custom kitchen in a neighborhood where $100,000 is the average sale price
- A 3-bedroom home, where one bedroom has been converted into a custom oversized closet
When a superadequacy exists, the fix is almost always more renovation to recoup value. But the fixes can get pricey, and they don’t always make sense.
What Functional Obsolescence Means For Real Estate Appraisers
When an appraiser identifies functional obsolescence during a real estate appraisal, it generally points to a loss in value. But not always. The appraiser might adjust their valuation approach to focus less on the comparison of a property’s value with values of properties nearby (the sales comparison approach). Instead, the appraiser may use the cost approach and value the property in terms of its total cost to replace plus the land value.
What Functional Obsolescence Means in the Real Estate Process
When a property is functionally obsolete, it means different things to owners, buyers, investors, and lenders.
- Property Owners. The property owner might have difficulty selling a functionally obsolete property. If curable functional obsolescence is the issue, they might consider updating the property before listing it for sale. If incurable functional obsolescence or a superadequacy is the problem, they might want to wait out the market to sell or take a financial loss.
- Buyers and Investors. For buyers and investors, functionally obsolete properties sometimes make great investments. This is especially true for savvy buyers who don’t mind putting a lot of work into a home.
- Lenders. Lenders may be less willing to approve loans for functionally obsolete properties with evidence of depreciating value.
Functional obsolescence isn’t always a deal-breaker in real estate. Skilled property appraisers have the important job of putting it into context on an appraisal report. Sellers, buyers, and lenders can then use that report to make better real estate decisions.
Learn More About Real Property Appraisal With The CE Shop
Whether you’re looking to learn more about real property appraisal, considering a career change, or working on your CE – The CE Shop has you covered. Visit the Appraisal Essentials blog for insights on the industry. Or get your appraiser license and complete your appraiser CE with us by your side.
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