Economic Obsolescence

In the process of determining the value of residential real estate, much of what you will evaluate will be within the property lines. You will start by answering a host of questions about the property itself, such as:

  • How many bedrooms does it have?
  • How many bathrooms does it have?
  • How many square feet is the house?

Of course, this is always context dependent. The very process of estimating the value or sale price admits this by using comps, or similar properties within the same neighborhood.

If they aren’t within the same neighborhood, they are no longer considered comparable, even though they may have the same number of bedrooms, bathrooms and other details. Two homes that are identical in every other way can have a very different valuation if they are in different neighborhoods.

So we implicitly know that there are factors off the property that will impact its value tremendously. This is why we have the famous real estate phrase “Location. Location. Location.”

 

What is Economic Obsolescence?

Economic obsolescence is depreciation of the property due to factors in the surrounding neighborhood which impact its economic utility. This is also termed external obsolescence because it occurs outside the property lines of the piece of real estate in question, yet impacts the value of that property.

What is an Example of Economic Obsolescence?

A rise in neighborhood crime can negatively impact the value of the neighborhood and the properties therein. A wave of foreclosures that leaves behind vacant and derelict properties can also seriously impact the value of the rest of the homes.

One potential cause includes too many people moving away who are college educated. The book The Tipping Point indicates that there is a point past which a loss of a few educated locals can so seriously damage the fabric of the neighborhood that crime skyrockets thereafter.

A change in zoning may also lead to external obsolescence. This can fundamentally change the character of the neighborhood in negative ways. For example, if it becomes legal to run a bar or similar in a previously straight-laced area.

Is Economic Obsolescence Curable?

The short version is “No.” If you own a property in a deteriorating neighborhood, there is probably not much you can do to fix it because the problem is external to your property, hence the term external obsolescence.

You don’t directly control what goes on in the surrounding neighborhood, so you have limited ability to resolve the kinds of problems to which this term applies. Plus, because they occur at the neighborhood scale, these tend to be expensive problems that take a long time and a lot of effort to resolve, if they can be resolved at all.

But sometimes people do fight external obsolescence. Jane Jacobs became famous for her writing precisely because she was involved in fighting such trends in her own neighborhood. If you are unable or unwilling to move, her writings may be of interest to you. But do keep in mind that external obsolescence is so hard to remedy that most sources simply state “Nope, there is no cure for it.”

Economic Obsolescence vs Physical Obsolescence

Another kind of depreciation is physical obsolescence, sometimes called functional obsolescence. These are factors directly on the property, but in some cases they are a liability only because of upgrades to surrounding properties.

A simple example that is clearly and obviously physical obsolescence is if the house is in an older neighborhood, so it has a one car garage but you are a stereotypical modern two-car family. If there is also no street parking and a narrow driveway, you have a serious problem.

A less clear situation is if your house lacks a Master Suite, you have lived there for years and Master Suites have become all the rage in the neighborhood. One assessor might say this is physical obsolescence because the lack of a Master Suite is something on the property itself. Another might say this is economic obsolescence because it only matters due to changes in the surrounding neighborhood.