What is Functional Obsolescence
Functional obsolescence, a term commonly used in real estate, is a reduction of an object's usefulness or desirability because of an outdated design feature that cannot be easily changed. The application of the term varies per industry. For example, in real estate, it refers to the loss of property value due to an obsolete design feature, such as an old house with 1 bathroom in a neighborhood filled with new homes featuring at least 3 bathrooms.
BREAKING DOWN Functional Obsolescence
Consumers can mitigate losses caused by functional obsolescence by considering the long-term usefulness of purchased goods. An item can be unattractive to consumers if its design prevents upgrades or connectivity with compatible devices. Many consumer electronics, such as smartphones, are known for their functional obsolescence due to the constant introduction of newer, refreshed versions.
Functional obsolescence is not exclusive to consumer electronics and real estate. For example, before the late 1990s, most households were filled with bulky, heavy tube televisions. As a result, entertainment centers were constructed to accommodate their weight and size. Today, most households are filled with sleek, lightweight flat-screen televisions, rendering the old entertainment centers functionally obsolete. To keep pace with the technological advances of consumer electronics, furniture manufacturers often redesign their products.
Companies also take into consideration functional obsolescence in long-term business planning. Depreciation of an asset is one example of quantifiable functional obsolescence. Companies can use various accounting methods to calculate the depreciation of an asset on its books, but the overall goal is to measure and track an asset's declining usefulness over time. This method of business planning also helps companies anticipate the need to sell or repurchase new assets.
Functional Obsolescence and Real Estate
In real estate, functional obsolescence usually leads to a lower appraisal value. Real estate can exhibit functional obsolescence if its design features are outdated, not useful, or not aligned with market tastes and standards, such as when an old house is located within a neighborhood of new homes. Consider a 1950s house with 3 bedrooms and 1 bathroom located in a gated subdivision filled with 2-story 5 bedroom, 4 bathroom houses. Because the old house does not have the capacity that buyers in this market want, it is said to be functionally obsolete even if it is still in good condition and is perfectly livable. In the case of real estate, some features can potentially be renovated to overcome functional obsolescence.