Over time, real estate is subject to fluctuations in value. Some properties will be maintained well by the owners, and if situated in a good location may eventually become historic places. However, the value of other real estate may decline precipitously due to a phenomenon known as property obsolescence. When investing in real estate it is important to familiarize yourself with the different types of property obsolescence that can occur.
This results from outside factors which adversely affect the value of a property. A classic example is a well maintained house that just happens to be located in a neighborhood that goes downhill. Even if the homeowner has invested a considerable sum in remodeling the home, adding new fixtures and paint with a manicured lawn, the poor state of the neighborhood will still negatively impact its value.
Appraisers, who are responsible for deciding the value of real estate, will use multiple types of data in order to determine the extent of obsolescence. This data may consist of financial documents, comparisons to other properties in the area, and the standard selling price for similar real estate within the region. If the real estate is used for commercial purposes, this will also be taken into consideration, along with zoning and safety laws and whether or not the property adheres to them.
This type of obsolescence involves the physical deterioration of the property. The two main culprits behind this are age and wear (also known as entropy). The end result is depreciation in terms of what the property is worth. All real estate is subject to physical obsolescence over time, but the degree is determined by the quality of the construction as well as the care that the owner has put into it. Properties that are well built with durable materials and which are maintained regularly will have much less physical obsolescence than those which are not, giving them a higher value. In fact, such properties tend to appreciate rather than depreciate over time.
This phenomenon occurs when commercial real estate is no longer capable of functioning in the manner in which it was intended. A good example is an old, worn down apartment that is not sufficient for human habitation. As a result the property loses its value and generally becomes an eye sore for any community it’s located in. Another example is when a piece of real estate uses technical components which become obsolete, resulting in the property no longer being profitable. This is usually because the cost of operating the facility is greater than the profits brought in.
Of the three types of obsolescence, only one can be controlled (to some extent) by the owner. Little can be done for a property in a neighborhood that deteriorates, and the same is true for functional obsolescence. When the value of a property is determined, the appraiser should consider the total value of services and goods which are rendered by it.