What Is Functional Obsolescence Real Estate? Everything You Need To Knw

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functional obsolescence real estate

What is functional obsolescence real estate?

Functional obsolescence is a type of real estate (property) depreciation that applies to buildings and other structures. It refers to the loss in value due to the inherent characteristics or behavior of the structure. For example, an office building will lose value if it doesn’t have enough parking spaces for employees because workers may not want to walk long distances between their cars and the office (and the building will likely need more oversized parking lots/garages). Or, its walls might be made of brick instead of steel-reinforced concrete, which decreases safety in case of earthquakes. Structural issues can cause functional obsolescence and outdated HVAC or inefficient water/sewage systems. A specific property’s functional obsolescence is often measured by its economic depreciation, which can be defined as:

“The reduction in the value of a capital asset due to any factor (as age and deterioration) that affects its ability to produce or render services.”

Functional obsolescence in real estate

In the case of real estate, functional obsolescence means that a property has been rendered obsolete for its current use, either because there are more efficient ways of achieving the same purpose or because it simply no longer fits into contemporary society. In other words, a building’s owner will never recuperate all money spent on buying and maintaining their investment. Functional obsolescence doesn’t have anything to do with the property’s location, condition, or remaining useful life.

Obsolete industrial buildings

Several buildings are functional obsolescence because they are no longer efficient for their current use. This is especially true in the case of obsolete industrial buildings located in economically less developed areas. It wouldn’t make financial sense to invest in retrofitting them for a different purpose. Houses built before 1930 often have old-fashioned heating systems that require too much energy to maintain, making them an inefficient resource nowadays. Another example would be real estate that is expensive to repair or has fallen into disrepair due to poor maintenance (which can cause things like mold). Other causes of functional obsolescence include changing technologies and economic conditions (like the Great Depression).

Empire state building

Functional obsolescence is also seen in highly successful buildings. One example is the Empire State Building, which was built with an innovative elevator system that didn’t require stops on every floor (unlike other high-rises at the time). However, recent decades have brought more efficient ways of getting around tall buildings; for instance, people don’t lean against walls anymore because they are afraid of catching germs. This makes it unnecessary to give passengers a chance to exit between floors like it used to be back in 1930. The Empire State building remains profitable despite its functional obsolescence because its prime location allows companies to pay higher rents than they would if they chose another skyscraper instead. Economic depreciation is the reduction in real estate value due to economic and non-economic factors. Economically, it can be defined as:

“The amount by which a building, property, or piece of equipment declines in value from its original purchase price because of normal wear and tear, physical deterioration, changes in market demand or competition, functional obsolescence, or other causes.”

Non-economically speaking, functional obsolescence means that a structure’s value decreases for reasons other than its age, condition, or location. For example, while a house built in 1930 might have had sufficient parking space when purchased initially (let’s say ten parking spaces), it might now need more because of an increase in population density. The value of this property will decrease because of its functional obsolescence, but it will remain profitable because its location is still desirable.

What is the difference between real estate functional obsolescence and economic depreciation?

Real estate functional obsolescence can be defined as a reduction in value due to any change that affects the property’s ability to produce or render services. Real estate economic depreciation means precisely what it says: Loss of value due to economic factors (like changes in demand). These differences are subtle, but they serve different purposes for investors, lenders, and other real estate professionals. A particular property’s functional obsolescence is often measured by its economic depreciation, which can be defined as: “the reduction in the value of a capital asset due to a change in its physical condition, location, or other non-economic factors.

Read More: What Is Police Power In Real Estate? What Are The Basic Terms And Conditions For Police Power In Real Estate?

Reasons that a building might become functionally obsolete

Many different reasons a building might become functionally obsolete: outdated heating systems, lack of parking spaces due to increased patronage at area establishments, removal of a “focal point” (like railroad tracks) from within a view, and endless possibilities. One example is the Empire State Building, which was built with an innovative elevator system that didn’t require stops on every floor (unlike other high-rises at the time).

However, recent decades have brought more efficient ways of getting around tall buildings; for instance, people don’t lean against walls anymore because they are afraid of catching germs. This makes it unnecessary to give passengers a chance to exit between floors like it used to be back in 1930. The Empire State building remains profitable despite its functional obsolescence because its prime location allows companies to pay higher rents than they would if they chose another skyscraper instead.

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