External obsolescence

From CEOpedia | Management online

External obsolescence is "a temporary or permanent impairment of the utility or salability of an improvement or property due to negative influences outside the property [1]." It is "a loss in value caused by negative externalities that is almost always incurable[2]." What is more, the guide claims that it may be imposed by economic or locational factors. It can be permanent or temporary. "Appraisers typically employ external obsolescence in a business enterprise. That operates as a special-purpose property, such that a shift in industry assets could cause the company to incur a reduction in revenue, profit margin, or return on investment metrics[3].

Types of properties

External obsolescence performs when the landlord cannot earn a market-based rate return from investment. There are three types of industrial properties classifications[4] :

  • general-purpose - are used in many different projects such as warehausing, distribution or light manufacturing. This type of property doesn't need any special adaptation and building attributes for its functional purpose.
  • single-purpose - it is a type of property, that is designed specially for specific use. It can not be adopted to any other that current uses.
  • special-purpose - properties that are customized for a particular industrial process or function. It has the highest value as originally intended.

What may cause external obsolescence

External obsolescence may be caused by environmental problem such as a deteriorationg neighbourhood, a location that is not suitable for everyone (for example when property is located near the airport, or close to railroad, commercial district). It can be also caused by economic recession that creates a sluggish market. In general, external obsolescence results in depreciation of the property's value. It may also make the land less valuable.

It is used to describe all factors which negatively influence property value. It can include problems with transportation infrastructure (traffic jams), regulatory hurdles (e.g. regarding environmental protection), lack of competent workforce, depletion of mineral resources, growing competition nearby (e.g. important issue in hotel industry)

"To prove external obsolescence, a party can demonstrate the effect of negative externalities on value through direct comparison with other properties with and without external obsolescence, based on the availability of data for that type of analysis. An alternative "is the capitalization of income lost due to the effect of the externality"[5]. However, there are no rules over the standard in proving this matter. " More specifically, jurisdictions disagree whether taxpayers should have to prove the actual harm of external obsolescence on that subject property. The Eurofresh and Minnesota Energy cases demonstrate this disagreement"[6].

Examples of External obsolescence

  • Changes in the local economy: Changes in the local economy can have a significant impact on the value of a property. For example, if a once-thriving industrial area experiences a downturn, the value of the buildings and land in that area could decrease significantly.
  • Changes in the neighborhood: Changes in the neighborhood can also lead to external obsolescence. For example, if a proposed development project decreases the desirability of an area, the value of the properties in that area could be negatively impacted.
  • Changes in technology: Advances in technology can also lead to external obsolescence. For example, if a new technology renders an existing technology obsolete, the value of the properties that use that technology could decrease significantly.
  • Changes in demographics: Changes in demographics can also lead to external obsolescence. For example, if an area experiences an influx of new residents who have different tastes and preferences than the previous residents, the value of existing properties in that area could decrease.
  • Changes in local laws: Changes in local laws can also lead to external obsolescence. For example, if a new zoning regulation decreases the allowable uses for a property, the value of the property could decrease.
  • Environmental risks: Environmental risks, such as flooding, can also lead to external obsolescence. For example, if a property is located in an area prone to flooding, its value could decrease significantly due to the risk of flooding.

Advantages of External obsolescence

External obsolescence has some advantages, such as:

  • Increased competition amongst properties in the same area, creating more choice for consumers.
  • The ability to take advantage of changing market trends and improvements in technology.
  • The ability to increase the value of a property by making it more attractive to potential buyers.
  • The ability to offer more competitive prices for a property, which can attract more buyers.
  • The ability to increase the value of a property by making it more desirable to potential renters.
  • The opportunity to create a more desirable neighborhood by capitalizing on new businesses and developments.

Limitations of External obsolescence

External obsolescence can have a negative impact on the value of a property. The following are some of the limitations of external obsolescence:

  • Changes in the neighborhood or local market that reduce the desirability of the property, such as increased crime, decreased infrastructure quality, or increased traffic.
  • Environmental changes that could decrease the value of the property, such as the presence of a new industrial facility nearby, or the introduction of new zoning laws.
  • Changes in the economy, such as a recession, that could decrease the demand for the property.
  • Changes in government regulations that could affect the property, such as increased taxes or stricter building codes.
  • Technological advances that could make the property obsolete, such as the development of new materials or construction techniques.

Other approaches related to External obsolescence

External obsolescence can be offset by several other approaches. These include:

  • Strategic remodelling and renovation of a property to meet current market demands;
  • Exterior improvements to reduce the negative impact of external factors, such as landscaping, painting and minor repairs;
  • Enhancing the neighbourhood's image and reputation;
  • Creating amenities or services that can attract buyers or renters.

In summary, there are various approaches to offset external obsolescence, ranging from strategic remodelling and renovation to enhancing the neighbourhood's image and reputation.

Footnotes

  1. ↑ Appraising Residential Properties (2013), "Appraisal Institute 2013a", 576, za: M. J. Wildes, (2017) Minnesota’s Rejection of Heightened Standard for External Obsolescence Is Proper Interpretation of The Appraisal of Real Estate
  2. ↑ Derbes (1997). "Application Journal of Property Tax Assessment & Administration" • Volume 15, Issue 1 73
  3. ↑ Guardian Energy (2015), LLC v. County of Waseca https://mn.gov/tax-court-stat/published%20orders/2017/Guardian%20Energy%20v%20Waseca%20Co%2005-16-16.pdf
  4. ↑ Derbes (1997). "Application Journal of Property Tax Assessment & Administration" • Volume 15, Issue 1 73
  5. ↑ Appraising Residential Properties (2013), Appraisal Institute 2013a, 576, za: M. J. Wildes (2017), Minnesota’s Rejection of Heightened Standard for External Obsolescence Is Proper Interpretation of The Appraisal of Real Estate
  6. ↑ M. J. Wildes, (2017), Minnesota’s Rejection of Heightened Standard for External Obsolescence Is Proper Interpretation of The Appraisal of Real Estate


External obsolescence — recommended articles
Economic obsolescence — Opportunities and threats — Industry environment — Examples of threats — Threat of new entrants — Monopoly — Barriers to exit — STEEPLE analysis — Commercial facility

References

Author: Filip Fikas

Retrieved from "https://ceopedia.org/index.php?title=External_obsolescence&oldid=92201"