If you’ve ever seen the movie, Falling Down, with Michael Douglas you may remember the scene where a man who was recently laid off was protesting in front of his former place of business with a sign that read: “Not Economically Viable.” From the employer’s point of view the gentleman no longer had the skills required to justify his employment. His value to the employer had declined.
This refers to the concept of obsolescence; defined as the state of being which occurs when an object, service, or practice is no longer wanted even though it may still be in good working order. Owners have varying levels of control over the degree to which their properties are affected by the concept of obsolescence, but all real estate is subject to it. This is the primary reason behind cost recovery deductions for real property.
There are 3 types of obsolescence affecting real estate:
- Functional Obsolescence refers to a decline in value due to its architectural design, building style, size, outdated amenities, local economic conditions and changing technology. The reduction in usefulness or desirability is based on the presupposition that the feature cannot easily or cost-effectively be changed. One example would be a multi-story office building that does not have an elevator.
- Economic Obsolescence refers to a decline in property due to external factors; meaning that the owner has little to no ability to change the factors that are negatively affecting the property. Examples of economic (sometimes called external) obsolescence can be zoning changes, recession, adverse traffic pattern changes, construction of public nuisance type properties and utilities, i.e. county jails, sewer treatment plants, etc. in close proximity to the property, etc.
- Physical Obsolescence refers to a decline in property value due to gross mismanagement and physical neglect resulting from deferred maintenance. All real property is subject to physical deterioration over time but the degree to which a property actually deteriorates can be mitigated by the owner. Examples of physical obsolescence include leaking roofs, old HVAC units, old/non-energy efficient windows, etc.