Functional Obsolescence in Real Estate

Can you recognize a property with “good bones”? If so, then you’re likely familiar with the term functional obsolescence. 

Functional obsolescence refers to fundamental problems within a home that decrease its value and may make it a less worthwhile investment. Homes with inherent issues that decrease their marketability are considered functionally obsolete. 

If you aren’t familiar with this term, don’t fear. In this article, we’ll cover what it means for a property to have “good bones” as well as the reverse scenario: When outdated design features, structural issues, or other problems cause functional obsolescence and negatively impact the market value of your property. 

Read on to how to recognize both types of properties and discover the key characteristics that make a property resilient and valuable for years to come. 

What is Functional Obsolescence?  

The term ‘obsolescence’ in general refers to the process of something becoming outdated or obsolete. ‘Functional obsolescence,’ by extension, refers to outdatedness that is due to inherent design features that can’t be easily changed. 

In real estate, this term has an even narrower meaning: 

Functional obsolescence real estate definition: Loss or reduction in the value of a property due to factors internal to the property itself, such as outdated design, poor condition, or degradation of amenities. 

In laymen’s terms, functional obsolescence is when a home doesn’t meet market expectations on a functional level. Features of the home are outdated and cannot be easily improved because they are an inherent part of the property. Curable functional obsolescence may be able to be resolved by making upgrades to the property. In some cases, however, incurable functional obsolescence cannot be reconciled by the property owner at all. This reduces the desirability of the property and, in turn, its value.  

For example, an old house with one bathroom located in a neighborhood filled with newer homes that have at least three bathrooms is a functionally obsolete property in that market. This home simply cannot compete with other properties in the market. Its appraisal value would be lower since property appraisals depend, in part, on comparison to local comps. However, if an investor with substantial time and money were to purchase the home, add several more bathrooms, and perform major renovations, they might be able to sell it for a profit. It would not, however, be an easy task, nor would many investors be willing to take on risk that significant. 

Keep in mind that over-improvements, such as excessive customization, can also contribute to incurable functional obsolescence. For instance, a luxury home with a private recording studio, indoor pool, or underground basketball court may be so customized that it has trouble selling on the market and becomes functionally obsolete as well. 

Understanding and addressing the functional obsolescence definition is crucial for maintaining and increasing property value in your real estate market. 

What is the Difference Between Functional and Economic Obsolescence? 

Not all property depreciation is due to functional obsolescence. Property values can also decline due to economic obsolescence. 

Economic obsolescence refers to the decline of a property’s value due to factors external to the property and often outside the investor or homeowner’s control. These external factors could include new laws, zoning changes, crime rates, cost of living, environmental hazards, etc. For property owners facing this kind of incurable obsolescence, the only way to mitigate its effects is to manipulate the factors within the property owner’s control, such as playing into market demand, appealing to market tastes, and attempting to increase their real property appraisal. 

Economic obsolescence is approached differently to functional obsolescence even though both cause the similar result of lowered property values. You can learn more about economic obsolescence in our article about it here. 

How to Mitigate Functional Obsolescence 

As an investor, what strategies can you implement to mitigate the risk of curable obsolescence in your properties? 

Substantial renovation is often necessary to overcome functional obsolescence in real estate. For example, a 1950s-style house in a modern neighborhood may suffer from functional obsolescence and need to be stripped to its bare bones to overcome it. However, other homes may have more limited problems that can be addressed by upgrading a particular room, amenity, or appliances. 

Here are a few general tips investors can use to avoid functional obsolescence: 

• Update features and amenities regularly to enhance the property’s competitiveness. 
• Avoid custom features and other over-improvements that could lead to obsolescence down the line. 
• Conduct a thorough assessment of the property’s long-term usefulness to identify incurable obsolescence before making any purchasing decisions.  
• Prioritize functionality over fads or trends that are currently “in” but may not be in a few years. 
• Be able to quickly identify design limitations when evaluating a potential real estate investment property. 

By investing in renovations, staying mindful of design trends, and anticipating future usability, you can effectively mitigate the risks of obsolescence in real estate properties. 

Renovations that Keep Functional Obsolescence in Check 

Which renovations are most effective when it comes to fending off functional obsolescence over time? 

Functional obsolescence can sometimes be inevitable if you hold on to a property for long enough. However, by making regular updates and renovations to outdated features in your property, you can prevent the majority of worst-case scenarios where your property is too outdated to sell at a competitive market price. 

Here are a few renovation ideas to consider: 

• Upgrade old appliances to newer, more energy-efficient ones. 
• Update kitchen and bathroom features like cabinets, sinks, and other fixtures 
• Replace worn-out flooring with durable, timeless flooring like hardwood to avoid functional and physical deterioration 
• Reconfigure room layouts to better suit current trends and lifestyles. For example, adding a home office space to a home with a large amount of open first-floor space can help transition the home into one suitable for a new work-from-home generation. 
• Modernize over-customized exterior features that may interfere with your property’s curb appeal. 

By modernizing these aspects, you not only improve the functionality and appeal of your property but also increase its value in the real estate market. Although upgrades can be major projects, some of these renovation ideas are simple and relatively low-cost. They are probably worth the investment, as many can revitalize and breathe new life into older homes, making them more attractive to potential buyers as well as current tenants. 

What you’re looking for, ultimately, is long-term relevance in an ever-evolving real estate landscape. The question of which renovations will get you there can be subjective, but you can know better than anyone else by paying attention to local market trends as well as following some of the commonsense principles described above. 

Contrasting Functional Obsolescence with “Good Bones” 

Desirable properties are often said to have “good bones.” What does this mean exactly, and how does it differ from properties that are functionally obsolete? 

Homes with good bones are homes with their major systems in excellent shape, including plumbing, heating, ventilation, and electrical systems, regardless of what their exteriors may look like. They also generally have good floor plans that “flow” smoothly. 

These are homes that will clearly retain their quality over time, whereas homes with functional obsolescence will lose their appeal and value. Homes with good bones often feel spacious, with high ceilings and ample natural light streaming through large windows. They have solid infrastructure, with modern and smoothly functioning electricity and plumbing, which can save both an investor and a potential buyer or tenant money in the long run. They may need a new coat of paint or some attention to decoration or landscaping, but their core, structural and functional components are intact. 

Identifying Homes with Good Bones 

To identify homes with good bones, start by inspecting the structural integrity. Look for signs of solid construction such as straight walls, level floors, and a sound foundation. Pay attention to floor plans by walking through the home and assessing the flow between rooms. Additionally, check that the property needs only minimal repairs, indicating that it is well-maintained. 

Hiring a real estate agent and home inspector can help you uncover hidden issues, ensuring that the home’s bones are in excellent condition despite any superficial outward appearances. 

Conclusion 

A savvy real estate investor needs a deep understanding of the concepts of functional obsolescence and good bones in the market. 

By recognizing the signs of obsolescence and identifying properties with strong structural foundations, you can make more informed choices about which property will be the next to join your portfolio. Remember: Renovations can overcome some functional obsolescence challenges but not all, so think carefully before investing in a property with issues beyond your budget or power to fix.