Economic Obsolescence

Definition

Economic obsolescence, also referred to as external or environmental obsolescence, is a form of depreciation that results in a decline in the value of real estate due to external factors beyond the control of the property owner. These factors can include changes in the surrounding environment, new construction projects, modifications in area utility rates, or any other external influences that negatively impact the desirability or functionality of a property.

Examples

New Industrial Development: A luxury residential area can experience economic obsolescence when an industrial plant is constructed nearby. The noise, pollution, and industrial traffic can diminish the area’s appeal, leading to a drop in property values.
Environmental Changes: Natural occurrences or human activities resulting in pollution of nearby waterways can lead to economic obsolescence. The adverse effects on the environment significantly impact property values in the vicinity.
Rate Changes by Utility Companies: When regulatory agencies alter the rate structures for utility companies, this can cause economic obsolescence for public utilities and railroad companies by increasing operational costs and reducing profitability.
Infrastructure Development: The construction of noisy or unattractive highways near residential neighborhoods can lead to decreased property values, exemplifying economic obsolescence.

FAQs

What is economic obsolescence in real estate?

Economic obsolescence refers to the loss of property value due to external factors, such as environmental changes, new nearby developments, or economic conditions, that affect the property from the outside.

How does economic obsolescence differ from physical obsolescence?

While physical obsolescence pertains to wear and tear or deterioration within the property itself, economic obsolescence is caused by external factors unrelated to the physical condition of the property.

Can economic obsolescence be reversed?

Economic obsolescence is generally irreversible, as it is dependent on factors beyond the owner’s control. However, mitigation efforts such as community improvement projects or environmental cleanup initiatives can sometimes help alleviate the impact.

What is an example of economic obsolescence?

An example of economic obsolescence is a residential area losing property value because of the construction of a nearby noisy highway that detracts from the neighborhood’s appeal.

How is economic obsolescence assessed in property appraisal?

During the property appraisal process, appraisers take into account external factors which could negatively impact the property’s value, such as changes in the local environment, new infrastructure projects, or economic shifts in the area.

Depreciation (Appraisal): The overall reduction in property value due to various forms of wear and tear, including physical, functional, and external factors.
Functional Obsolescence: A decrease in property value due to outdated design or features that are no longer functional or desirable.
Physical Obsolescence: Loss in value resulting from the physical deterioration of a property.
Externalities: Economic side effects or consequences that affect third parties and can cause shifts in property values.

Online Resources

References

Appraisal Institute, “The Appraisal of Real Estate”
Federal Reserve Economic Data (FRED), “Economic Indicators and Housing Market”
Investopedia Articles on Real Estate and Economic Obsolescence
ULI Urban Land Institute - Research on External Influences on Property Values

Suggested Books for Further Studies

“The Appraisal of Real Estate” by Appraisal Institute
“Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher
“Real Estate Principles: A Value Approach” by David C. Ling and Wayne R. Archer
“Investing in Duplexes, Triplexes, and Quads” by Larry Loftis

Real Estate Basics: Economic Obsolescence Fundamentals Quiz

### Does economic obsolescence apply to internal or external factors affecting property value? - [ ] Internal factors - [x] External factors - [ ] Both internal and external factors - [ ] Neither factor applies > **Explanation:** Economic obsolescence strictly pertains to external factors that impact the property’s value, such as changes in the local environment, new construction, or economic shifts. ### What is another name for economic obsolescence? - [ ] Functional obsolescence - [x] External obsolescence - [ ] Physical obsolescence - [ ] Market obsolescence > **Explanation:** Economic obsolescence is also known as external obsolescence due to its nature of being caused by outside influences rather than internal property conditions. ### Which of the following scenarios exemplifies economic obsolescence? - [ ] A property with a leaking roof - [ ] A home with outdated electrical wiring - [x] A residential area experiencing value loss due to nearby industrial construction - [ ] A building with obsolete heating systems > **Explanation:** Economic obsolescence is illustrated when external factors, such as nearby industrial construction, cause a drop in the value of a residential area. ### Can economic obsolescence be influenced by actions taken within the property? - [ ] Yes, always - [ ] Sometimes, depending on the nature of the actions - [x] No, it is purely driven by external factors - [ ] It cannot be determined > **Explanation:** Economic obsolescence is driven solely by external factors and cannot be influenced by actions taken within the property itself. ### Which institution might affect property values resulting in economic obsolescence for railroads or utilities? - [x] Rate-making authority of a public utility or railroad - [ ] Real estate agents - [ ] Local tourist boards - [ ] Bank regulators > **Explanation:** The rate-making authority of a public utility or railroad might affect property values, leading to economic obsolescence for railroads or utilities. ### How does infrastructure development, like constructing highways, contribute to economic obsolescence? - [ ] By improving accessibility - [x] By making nearby properties less desirable due to noise and unattractiveness - [ ] By increasing taxation - [ ] By enhancing property aesthetics > **Explanation:** Infrastructure development, such as building highways, can contribute to economic obsolescence by making properties nearby less desirable because of increased noise and unattractiveness. ### Which type of property depreciation directly results from economic obsolescence? - [ ] Functional obsolescence - [x] External obsolescence - [ ] Physical deterioration - [ ] Internal depreciation > **Explanation:** Economic obsolescence results in what is known as external obsolescence, as it stems from outside influences that depreciate property value. ### Are properties able to recover fully from economic obsolescence once the impacting factors have been removed? - [ ] Yes, they will fully recover - [x] Not usually, as it is often irreversible - [ ] Sometimes, depending on market conditions - [ ] Always, provided structural repairs are undertaken > **Explanation:** Properties affected by economic obsolescence often do not fully recover even if the impacting external factors are removed, as the influences are typically deeply ingrained. ### What kind of real estate obsolescence is caused by preferences changing over time, independent of external factors? - [x] Functional obsolescence - [ ] Physical obsolescence - [ ] Economic obsolescence - [ ] Non-obsolescence > **Explanation:** Functional obsolescence is due to changing preferences or advances in technology over time, independent of external factors. ### In a property appraisal context, what critical information must be reviewed to assess potential economic obsolescence? - [x] External factors impacting the property’s surroundings - [ ] The property's renovation history - [ ] Owner's financial records - [ ] Local buyers' intentions > **Explanation:** To assess economic obsolescence, appraisers review any external factors impacting the property’s vicinity that could affect its value.