Functional Obsolescence: What Is it and How Does it Affect Buyers and Sellers?
The term functional obsolescence has a few different applications depending on the industry, but in real estate it refers to a loss of property value due to style, space, or a particular design feature.
Written for ApartmentTherapy.com: https://www.apartmenttherapy.com/functional-obsolescence-259126
Buying a home is no small task. There are huge decisions to make: Are you looking for a turn-key or a fixer-upper? Is the longer commute worth the savings? There are also endless numbers to crunch: How does a fixed-rate mortgage compare to an adjustable rate? How much are you actually going to pay on this $200,000 home? And when figuring all of this out, it’s more than likely you’ll come across some brand new jargon to decipher.
One of the more common terms you might face during your search is what’s called “functional obsolescence.” For example, your realtor might refer to a less-than-perfect home at a great price as “functionally obsolete.” You know what functional means, and you know what obsolete means, but what does it mean for you, the home buyer and potential future seller? Here, everything you need to know, including if buying a functionally obsolete home makes sense for you.
What is Functional Obsolescence?
The term functional obsolescence has a few different applications depending on the industry, but in real estate it refers to a loss of property value due to style, space, or a particular design feature. Basically, functionally obsolete houses have either too much or too little of something compared to other houses in the area and on the market.
For example, let’s say you’re looking at an old house with two bedrooms and one bath in a neighborhood full of brand new homes featuring three-plus bedrooms and two-plus baths. The home you’re looking at would be considered “functionally obsolete” because though you could still live in the house, most people don’t want to because they can get a higher quality house in the area for only a small premium. This type of functional obsolescence is called deficiency because there is some feature or factor that makes the house deficient compared to other houses nearby.
Functional obsolescence can work the other way around too. A large, new home in a neighborhood of small, old homes would also be considered functionally obsolete due to its high quality compared to the rest of the neighborhood. This type is called superadequacy (also referred to as over-improvement) since the lower property values in the neighborhood mean that people won’t want to pay the full-price of what these features are worth.
In addition to the overall home and location, functional obsolescence can also refer to individual design features. For instance, if a homeowner paints all of the cabinetry olive green or builds a swimming pool in the front yard, chances are, most prospective buyers will be turned off by those features, thereby rendering the home functionally obsolete.
In short, while functionally obsolete homes are fully functional, they become obsolete from an economic standpoint. Someone is going to have to compromise when buying a functionally obsolete house, be it the buyer via deficiency (any upgrades will have to come out of their pocket) or the seller via superadequacy (they will often have to compromise on selling price just to get it off the market).
Functional Obsolescence Appraisal
When it comes to appraising a functionally obsolete home, there’s one primary factor to consider: Is the obsolescence curable or incurable? In other words, can the functional obsolescence be easily fixed?
Incurable obsolescence occurs when it costs more to fix the problem then it will be worth in terms of raising property value. For example, if a home is extremely small and outdated compared to the rest of the neighborhood, then it’d be considered incurable because heavy renovations are needed to increase its value (and they might cost more than the money they’d bring back in when reselling).
On the other hand, curable obsolescence happens when the cost to fix something is both easy and makes sense financially. Ask yourself: Is it worth the trouble? If it’s the olive green kitchen cabinets that are turning buyers off, a simple can of white paint turns out to be more than worth the cost.
While it seems like a functionally obsolete home comes with complications, remember, it may be in your interest to give it a second look. “If that home with just one bathroom or the less-than-ideal layout is what gets you into your dream neighborhood without busting your budget, then it’s worth considering,” says Holly Hughes, a Realtor in Austin, Texas. Many times, functionally obsolete homes sit on the market for longer than the neighborhood’s average—which means the buyer is in a great place to negotiate. However, stay away from big incurable issues like houses with shoddy foundations and other old-school features like septic systems.
“If it’s too big of an issue, banks won’t lend on it,” Hughes adds.
In other words, if an otherwise fantastic home is functionally obsolete, that doesn’t necessarily mean it can’t be your dream home. You just have an extra factor to weigh in before making the final decision. Good luck!