For appraisers, functional obsolescence can be a challenging concept because the elements that influence property values may not be obvious or immediately apparent. To help you better understand what it means and how to pinpoint it, we’re exploring some examples, the different types of functional obsolescence, and how it can influence property values.
Additionally, we’re sharing insights from appraisers who answered our survey question, “When dealing with functional obsolescence in real property appraisal, what aspect do you find most challenging?”
Want to participate? Sign up for our newsletter to get the next “Appraisal Question of the Month” survey delivered to your inbox.
What is functional obsolescence?
The literal textbook definition from The Dictionary of Real Estate Appraisal explains functional obsolescence as, “the impairment of functional capacity of a property according to market tastes and standards.” To put it in laymen’s terms, it refers to the property’s depreciated usefulness or desirability tied to its outdated design, layout, or other feature which can’t be easily remedied.
Functional Obsolescence, the loss of a property’s value caused by obsolete design features, stands in contrast to other forms of depreciation, such as economic obsolescence or physical obsolescence. The former refers to a loss in property value tied to external factors outside of the owner’s control such as changes to zoning laws or environmental issues.
Physical obsolescence refers to the normal wear and tear of a property over time. Naturally, building materials and infrastructure will deteriorate in some way, and fixes to these issues may be either curable or incurable (see below).
A common way to think of functional obsolescence is in terms of cell phones: a type of technology which is constantly changing and being updated, causing older models to become worth less and less with time. As it relates to real estate, obsolescence can be seen in outdated architecture, impractical floor plans, or inadequate electrical systems.
Functional obsolescence may or may not be caused by trends in buyer or market preferences, outdated design, or even advances in technology.
Let’s look at a few examples:
- A home has three bedrooms, but to reach the third bedroom, you have to walk through the other secondary bedroom. Buyers are likely to see this as a flaw in the floor plan regardless of trends.
- A home has a separate formal living room, an enclosed kitchen, and a separate dining room. Today’s buyer prefers a more open, casual layout and may find the separate rooms a flaw in the floor plan, though this may change with market trends.
- A home with radiator heat and window unit air conditioning may be seen as functionally obsolete, and thus less valuable, as more modern homes have forced air furnaces and central air conditioning.
Types of Functional Obsolescence
The extent to which functional obsolescence affects a home’s value can depend on what type it is.
Curable Obsolescence
Curable obsolescence is a flaw in the property that can be “cured” with relative ease. Once the owner fixes, repairs, or updates the property to remedy the flaw, it will no longer be considered functionally obsolete, and the appraised value should reflect that.
Using one of the examples above, a homeowner could take out the wall separating the kitchen and dining area, creating a more functional space for buyers. Other examples of curable functional obsolescence can include a home with roof damage caused by normal wear and tear or a home with an outdated living room.
Incurable Obsolescence
As its name suggests, incurable obsolescence means the homeowner can’t remedy the property to eliminate the functional flaw easily or at all. An example is a residence that features an unconventional design where its primary entrance or living spaces face away from the street, contrary to the traditional orientation of neighboring homes.
This divergence from the typical street-facing layout may result in reduced curb appeal and market desirability, representing a form of functional obsolescence that is challenging to remedy without significant alterations to the property’s design.
Superadequacy
Superadequacy refers to either an element of the property or the property itself being excessively improved or having excessive features or qualities relative to the standard expectations for a property within a given market. The homeowner is unlikely to see a linear increase in market value.
For example, building a 5,000 square foot home may be seen as a superadequacy if it is built in a neighborhood comprised of modest-sized, two and three-bedroom homes. In this context, the property may not align with the typical features and market expectations of its neighborhood, making it less appealing to potential homebuyers. Consequently, this property might struggle to command the homeowners’ perceived market value for such a property within that specific location.
Identifying Functional Obsolescence
Measuring functional obsolescence and its effect on a property’s value can be challenging for even experienced appraisers. To ensure accurate reports, it’s essential you stay up to date and aware of market trends, and even code and building updates, as these changes over time do determine both curable and incurable obsolescence.
Functional Obsolescence and Appraisals
Oftentimes, functional obsolescence in the context of a real estate appraisal has to do with the loss of value in a property. An appraiser may offset this loss of value by focusing on the cost to update a property and the value of the land rather than comparing the property with neighboring ones.
This may be done using the Cost Approach: determining a property’s value by calculating the cost to construct a similar structure and then subtracting the amount of depreciation, as opposed to valuing the property based on the income the property generates, known as the Income Approach.
Instance of functional obsolescence are not always the end of the story in a real estate transaction. Real estate appraisers are tasked with finding the right context for a property’s value, which sellers, buyers, and lenders can then utilize in the real estate process.
What Aspects of Functional Obsolescence do Appraisers find most Challenging?
We asked our appraisal community, “When dealing with functional obsolescence in real property appraisal, what aspect do you find most challenging?” The top two answers were “supporting adjustments for it” and “finding comparable properties with similar obsolescence.”
Here are the full survey results, followed by comments from appraisers who shared further insights into these two common challenges related to functional obsolescence:
Supporting Adjustments for Functional Obsolescence
“The most challenging aspect of functional obsolescence is deriving an adjustment. Locating a comparable with similar functional obsolescence to support an adjustment is critical and time consuming. Diligent search efforts combined with real estate agent interviews usually provide the most effective solution.”
“Functional obsolescence is not a searchable criterion in any MLS database I’ve found. The ability to find a credible impact on other homes repeatedly is an anomaly. So, I may be able to generate a factor or dollar difference but having only one comp to determine with leaves you deciding on credibility or making no deduction if you don’t feel it’s a credible adjustment.”
Finding Comparable Properties with Similar Obsolescence
“Realtors don’t typically advertise a functional obsolescence in a house, so unless you know of another appraiser who has seen a similar situation, there usually is no way to easily pinpoint a comp with a similar problem.”
“Finding comps and supporting the adjustment are pretty much the same problem since you need comps, whether sales or rents, in order to make a market-based adjustment.”
“It is necessary to have sufficient market data to support findings.”
“FO is not a clear-cut issue, as this tends to be part of the overall marketability of the property. Most FO is subjective at best, as we don’t always see eye to eye with all users of real estate when in fact it could be your opinion that is not always correct.”
“I have appraised some properties in which my property was the only property experiencing a certain type of functional obsolescence. In one case there was a home that fronted to a moderate traffic street and sided to train tracks. In another instance, there was a home that sided to a 150′ water tower and backed to commercial property. In both instances, there were no other comps (on this planet) that had similar functional obsolescence.”
Stay up to date with market trends with our Unlimited CE Membership
When markets and trends change rapidly, McKissock can help you keep up. Our Unlimited Learning Membership offers the value and flexibility you want, providing full access to our Continuing Education course catalog, as well as appraisal certifications and a wide variety of topics in our Learning Library.
Editor’s note: This post was originally published on December 20, 2023 and updated in March 2024.
