Functional obsolescence

Functional obsolescence
See also

Functional obsolescence - a form of obsolescence of property that results "when layout, design, or other features are undesirable in comparison with features designed for the same functions in newer property[1]." It is also defined as "outmoded design in older structures or unacceptable design in newer structures[2]." Functional obsolescence may be caused by deficiency, the presence of a feature that ought to be modernized or replaced, or the look of a feature that is superfluous for the intended purpose[3]. Functional obsolescence is caused especially by technological change leading to modernize occupier demand requirements for individual properties. The other forms of obsolescence arose from changing aesthetic/ visual norms, legislation and accepted standards of the quality of the working life, and environmental factors[4].

Types of functional obsolescence[edit]

There are two categories of functional obsolescence (curable or incurable) relating to economic feasibility[5]:

  • An older house that has four bedrooms, but just a one single bathroom located off the kitchen suffers from functional obsolescence. This is an example of incurable functional obsolescence, because the cost of constructing brand new bathroom may probably exceed any increase in value to the house.
  • A newer home that is built with only two bedrooms, one room that is designed to be home office, would suffer from curable functional obsolescence. In most cases, three bedrooms are the minimum. Adding a closet to the home office space and changing it into bedroom would be easy. So the value of the home increases by an amount greater than what you have spent on building the closet.

Calculating functional obsolescence[edit]

Calculating functional obsolescence can be done in a number of ways. One method is to examine the cost to cure the functional deficiency. The cost-to-cure method is the most popular one in measuring obsolescence resulting from capacity deficiencies. "The second method is to calculate excess operating costs attributable to the subject asset over its remaining life"[6].

Functional obsolescence should be taken into account when buying real estate or other objects. Outdated products can be bought cheaper, but it will be harder to sell them in the future. It is not a problem if someone buys for own purposes and doesn't plan to sell for a long time.

In case of real estate also other problem arises. If the property was bought using loan the decreasing value of the property can reach value lower than value of loan. Then the mortgage is not enough to cover the loan and financial institution can ask for another guarantee.

Footnotes[edit]

  1. William L. Ventolo, Martha R. Williams (2001), Fundamentals of real estate appraisal, Dearborn Real Estate
  2. J. A. Yoegel, (2012), Real Estate License Exams For Dummies, John Wiley & Sons
  3. William L. Ventolo, Martha R. Williams (2001), Fundamentals of real estate appraisal, Dearborn Real Estate
  4. Dunse, N., & Jones, C. (2005). Rental depreciation, obsolescence and location: the case of industrial properties. Journal of Property Research, 22(2-3), 205-223.
  5. J. A. Yoegel, (2012), Real Estate License Exams For Dummies, John Wiley & Sons
  6. M. L. Zyla, (2009), Fair Value Measurements: Practical Guidance and Implementation, John Wiley & Sons

References[edit]

Author: Filip Fikas