What is Economic Obsolescence?
Economic Obsolescence Explained
Economic obsolescence, or external obsolescence, is a term used to describe the value of a property during an appraisal.
When a building or property experiences economic obsolescence, it means outside forces have caused the property to be worth less than before. This happens when changes to an area or surrounding environment cause the property to be less attractive to people, thus reducing the property’s value.
Not only does economic obsolescence make a property less valuable, but there is also nothing that can be done to the property itself to improve the situation.
Examples of Economic Obsolescence
- Economic obsolescence commonly occurs when there’s a change in the zoning laws that allow a less-desirable industry to locate next to a residential neighborhood (i.e. – any use that allows for excessive air pollution, noise, visual obstructions or lower perceived value). In some cases, this might cause not-in-my-backyard (NIMBY) protests and residents are sometimes successful in stopping such zoning changes, which can result in preserving their property value.
- Economic obsolescence could happen from a deteriorating neighborhood. This commonly happens during a housing crash or during an economic downturn, when many homes fall into foreclosure and become “zombie” homes. If there are enough empty homes in one area, all of them lose value, even those that remain occupied and well maintained.
- Economic obsolescence can also occur when an urban neighborhood loses a public transportation stop. A lack of close public transportation makes the entire area less convenient for many of its residents.
- The new construction of a road bypass can cause certain types of properties and businesses (like a gas station or hotel) to lose customers because fewer cars drive by their location on a regular basis. This is another example of economic obsolescence.
Other Types of Depreciation
There are two other types of economic obsolescence—physical deterioration and functional obsolescence. Sometimes, it is worth fixing these problems (curable) and sometimes it isn’t (incurable).
Physical deterioration can include issues like:
- settled foundation
- cracked walls
- a leaking roof
- peeling paint
- termite damage
These things can be fixed, but they may be expensive. If the repairs would cost more than what the property is worth, the physical deterioration would be considered incurable. If the increase in value is more than the cost of repairs, it would be curable.
Functional obsolescence happens when a building becomes outdated because of its design or materials and no longer meets the needs of its users. Some examples would be:
- Too few electrical outlets
- No central air-conditioning or heat
- Outdated kitchens and bathrooms
- Poorly designed floor plans
These issues could be curable or incurable, depending on the cost to fix them. If the increased value is higher than the renovation costs, the functional obsolescence would be curable. If not, it would be incurable. This usually occurs with older buildings, but it could also happen with a new building if it were poorly designed.