Economic obsolescence, also known as external depreciation, refers to the decline in a property’s value due to external factors that are typically beyond the control of property owners. These factors can include economic shifts, changes in nearby land usage, regulatory impacts, market trends, and broader changes in the economy.
Key Factors Leading to Economic Obsolescence
Industrial and Commercial Development
Economic obsolescence can occur when an industrial plant or commercial establishment is built near a residential property, leading to a decline in the property’s desirability and, consequently, its value.
Regulatory Changes
Changes in zoning laws, environmental regulations, or other government interventions can result in decreased property values if they limit the potential use of the property or increase the costs associated with its use.
Market Trends
Shifts in market preferences, such as a move away from urban living to suburban living or vice versa, can impact property values. For example, the rise of remote working capabilities has led to a decreased demand for office space in urban centers.
Broader Economic Conditions
Economic downturns, increases in interest rates, or changes in employment levels can all affect real estate values. Properties can depreciate if the local economy where the property is situated is considered declining.
Examples and Calculations
Example 1: Residential Property Near Industrial Plant
Consider an upscale residential neighborhood’s property that loses value because a large industrial plant is set up nearby. The decline in aesthetic appeal, potential pollution, and higher traffic levels contribute to depreciation.
Example Calculation
Let’s assume a residential home valued at $500,000. After the industrial plant is established, the property’s desirability drops, and it is reappraised at $400,000. The economic obsolescence in this case is:
Applicability in Real Estate Appraisal
Appraisal Considerations
Economic obsolescence is a critical factor appraisers and investors must consider. It is incorporated in the appraisal to accurately reflect the property value influenced by external factors.
Impact on Investment Decisions
Investors must analyze potential economic obsolescence when evaluating properties to ensure they make sound investment decisions. This helps in mitigating risks and accounting for potential depreciation in property values.
Comparisons with Other Forms of Depreciation
Functional Obsolescence
While economic obsolescence is external, functional obsolescence arises from outdated design features within the property itself, such as older appliances or inadequate floor plans.
Physical Depreciation
Physical depreciation is the wear and tear on the property over time—this involves the physical degradation of the building and its components.
Related Terms
- Depreciation: Depreciation refers to the overall decline in property value over time. It includes physical depreciation, functional obsolescence, and economic obsolescence.
- Appraisal: An appraisal is a professional evaluation of a property’s market value, considering factors like location, condition, market trends, and external influences like economic obsolescence.
FAQs
What is an example of economic obsolescence?
How is economic obsolescence measured?
Can economic obsolescence be reversed?
Is economic obsolescence considered in property taxes?
References
- The Appraisal of Real Estate (14th Edition) by Appraisal Institute.
- Real Estate Principles by Charles F. Floyd and Marcus T. Allen.
- Real Estate Economics by Nicholas G. Pirounakis.
Summary
Economic obsolescence is a pivotal concept in the domain of real estate, encapsulating the depreciation in property value due to external factors. Understanding this concept is crucial for property owners, investors, and appraisers to make informed decisions, accurately assess property values, and navigate the complex landscape of real estate investments.
