Real Estate Investing

What to Know About Economic Obsolescence and Appraised Value in Real Estate 

March 27, 2024

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Real estate investors know to expect the unexpected when it comes to preparing for housing market fluctuations. External factors like new laws, technology, or industry changes can impact your property’s worth and appraised value. 

Economic obsolescence refers to the loss of value due to external factors like those listed above. As a real estate investor, it’s important to be prepared for all kinds of changes in the market, from crime rates to environmental changes and economic downturns. While some factors are within your control to be resolved, like those derived from functional obsolescence, others require skilled adaptation to remain viable in the market. 

Read on to discover strategies to mitigate obsolescence, increase your property’s value, and make informed real estate decisions amidst economic challenges. 

What is Economic Obsolescence? 

Economic obsolescence is the decrease in a property’s value due to factors external to the property itself. Typically, these factors lie outside of the control of an investor. While you can modify your strategy or take steps to mitigate future losses, you cannot usually fix the specific cause of devaluation.  

Economic Obsolescence Factors 

There are a variety of external influences that can impact property values. Below are just a few of the many external factors that could contribute to economic obsolescence: 

  • Legislative changes 
  • Zoning laws 
  • Technological advances 
  • Industry economics 
  • Crime rates 
  • New land development 
  • Increase in cost of living 
  • New retail developments 
  • Environmental hazards 
  • Shift in employment patterns 

Any of the above factors (in addition to others related to the real estate industry) can lead to fluctuations in property values. By recognizing and addressing these external influences, property owners can better assess the true market value of their assets and make more informed decisions regarding their real estate investments. 

Economic vs. Functional Obsolescence 

Economic obsolescence differs from functional obsolescence, which refers to factors within the property itself that might impact its value. For instance, function obsolescence might result from undesirable physical or design features within a property like outdated layouts or technology, leading to a loss in value. This type of obsolescence can often be rectified by the property owner. 

On the other hand, economic obsolescence stems from external factors beyond the owner’s control. Understanding these distinctions is crucial in assessing the factors influencing a property’s worth and potential for appreciation in the real estate market. 

Examples of Economic Obsolescence 

Let’s say you own a property in a large metropolitan area. A rise in crime rates in this city could impact tenant safety, leading to fewer people wanting to live there. This could, in turn, impact property values—over time, rent prices will have to drop to encourage people to live in the city, which means properties in the area won’t be able to generate as much income and won’t be valued as highly.  

Another example: The closure of a major factory leading to job losses could result in a decreased demand for housing in the area, affecting property values. Understanding these examples can help investors and property owners navigate the complexities of economic obsolescence and make informed decisions regarding real estate investments. 

What is Appraised Value? 

Appraised value refers to a property’s worth as determined by a professional evaluation made by an appraiser. This assessed value is key to orchestrating a smooth and fair home buying process. 

During an appraisal, a professional real estate appraiser considers interior and exterior features, recent sale prices, market trends, property condition, age, and location to determine the appraised value of a house. Real estate agents can offer insights on a homes’ appraised values and comparisons to neighboring properties via a comparative market analysis. 

How long does an appraisal take? The answer to this FAQ is that it varies: Appraisals can take anywhere from a few days to more than a week. 

Market Value vs. Appraised Value 

A property’s market value, by contrast, is the price the home could sell for in the current marketplace, regardless of the value of its individual components. 

Market value, influenced by buyer affordability and offers, can vary based on market conditions. Your home appraisal value reflects the appraiser’s estimation, while market value is what buyers are willing to pay. 

You may also come across the term ‘fair market value’. Fair market value has the same meaning as market value, except a few additional assumptions are made: 

  • All parties are reasonably knowledgeable about the asset 
  • All parties are acting in their own best interests 
  • All parties are free of undue pressure 
  • Everyone has a reasonable period to fulfill the transaction 

Fair market value excludes certain valuations that don’t meet the above criteria, such as someone selling their property to a relative at a cheaper cost (thereby acting against their own best interests). 

Managing the Impact of Economic Obsolescence on Appraised Value 

As mentioned above, economic obsolescence can have a major impact on your property’s appraised value. Fluctuations in jobs, laws, economics, or other external factors in the local region can influence who is willing to buy in your market and how much they’re willing to spend. 

By diversifying your investments and monitoring market trends, you can effectively manage the impact of economic obsolescence on property values. Keeping a keen eye on external factors such as legislative changes, technological advancements, and industry economics is crucial. Additionally, staying informed about zoning regulations that could influence property values is essential. While you can’t always control these factors, you can always prepare for them and develop a plan to adjust or adapt your strategy as needed. 

Engaging with valuation experts to assess potential economic obsolescence risks can provide valuable insights. Understanding the distinction between functional and economic obsolescence will also help you address the issues you can control promptly. 

Conclusion 

Now that you understand the impact of economic obsolescence on your property’s value, you can take proactive steps to mitigate its effects. By differentiating between economic and functional obsolescence and exploring examples of economic obsolescence, you’re better equipped to navigate changing market conditions. 

As a best practice, consider strategies for mitigating the effects of obsolescence before they become an urgent problem. Staying informed about recent trends can help you make more informed decisions to protect your real estate investments in the face of economic challenges. 

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