External obsolescence are factors affecting real property value due to external causes beyond the control of the property owner, such as neighborhood changes, zoning modifications, and commercial or industrial development.
External obsolescence refers to external factors that exist beyond the property’s boundaries.
Understanding how to evaluate external obsolescence is critical for determining real property value pertinent in investment decisions and home-buying process—it can significantly impact marketability and profitability for owners and investors.
This article will help answer “what is external obsolescence?” and how it impacts property value.
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Understanding External Obsolescence
It’s important for appraisers to understand external obsolescence and how to uncover factors affecting the valuation that extend beyond the property itself. Some of the more obvious signs of external obsolescence include natural disasters and nearby development.
Here are several external factors that affect property values.
Economic Conditions
Changes in neighborhood demographics occur for a number of reasons. The pandemic changed neighborhoods throughout the US as people flocked to rural areas in search of a better work-life balance. While changes in neighborhood demographics can impact property values, with some areas experiencing increased values and others facing challenges, such as greater public safety challenges or declining property conditions.)
It is important to look beyond the house next door to determine how the neighborhood as a whole is doing.
Environmental Issues
Proximity to industrial sites, landfills, and power plants can negatively affect the subject property. Not all environmental issues are related to noise or smell. Concern for groundwater safety and pollution to adjacent rivers and lakes can also cause external obsolescence.
New Development
Certain types of development increase noise pollution or traffic, which can have deleterious effects on property values. Commerical and industrial development close to residential communities can increase the number of vehicles and types of vehicles. For instance, industrial areas increase truck traffic. Noise pollution can come from forklifts or other heavy machinery.
Zoning Changes
Zoning changes that increase density, allow infill projects, or permit mixed use can decrease property value. Infill projects are designed to increase values by redeveloping unused or underutilized land, typically within urban areas.
In established single-family zoning districts, a high-density housing infill project can have the opposite effect. Zoning changes that result in changes to traffic patterns, land use, and density can have positive and negative effects. When the effect decreases property value, it qualifies as external obsolescence.
Natural Disasters
Floods, hurricanes, or other natural disasters that damage nearby properties can decrease the value of the neighborhood. Hurricane Katrina had a devasting impact that spanned years as residents relocated to other states to create a better life. Fires can wipe out forested areas, leaving a scarred and undesirable landscape.
Distinguishing External Obsolescence from Other Forms of Depreciation
When evaluating real property, appraisers look at several forms of depreciation—or things that negatively affect property values. These can be internal or external factors.
Internal factors relate to the property itself and include physical deterioration and functional obsolescence. External factors, like those listed above, are related to issues beyond the subject property’s boundaries.
Physical Deterioration or Depreciation
Loss of value is most commonly caused by property deterioration due to wear and tear, age, and deferred maintenance. Deferred maintenance can lead to roof leaks, plumbing and electrical problems, and chipped paint. Age can cause foundation cracks. Excess wear results when the property is not used for its highest and best use. For example, multiple families living in a single-family home.
Identifying External Obsolescence in Practice
Appraisers look at the surrounding area to identify external obsolescence, including:
- Declining neighborhood desirability.
- Adverse changes in surrounding land use.
- Long-term infrastructure disruptions.
Appraisers use their local knowledge of the area, maps, aerial photography, and other data sources to evaluate external obsolescence. According to Fannie Mae, appraisers have included sketches pulled from prior reports, assessor’s records, and other sources to document and support their findings.
Measuring the Impact of External Obsolescence
Measuring the impact of external obsolescence poses many challenges. Nonetheless, the appraiser is tasked with determining a value—or loss of value—for the real property. Professional judgment and personal knowledge of the area, maps, and aerial photography are excellent tools to demonstrate changes over time in the area, but they do not equate to dollar value.
Some techniques appraisers can use include:
Paired Sales Analysis
This technique establishes a specific value for a specific feature by comparing similar properties that differ in only one characteristic. Features typically include a specific upgrade or improvement. While this is not the best tool, it is one that can be used in addition to other tools and professional opinions.
Market Surveys and Trend Analysis
Trend analysis focuses on location and how real estate is fairing under current market trends and conditions. The approach takes a broad look at external factors affecting value.
Income Loss
For commercial properties, including homes with established rental income, the income approach can help establish losses associated with external consequences. When evaluating income loss, appraisers can look at vacancy rates in the area. Increasing vacancies can be a red flag that something bigger is happening in the community.
Cost Approach
The cost approach is used to provide support in determining a property’s value when the property is unique or only limited comparable sales data are available. It estimates value based on reproducing or replacing the property. Depreciation in this instance is calculated based on three types: physical depreciation and functional and external obsolescence. These factors contribute to the effective age and remaining economic life of the property.
Addressing External Obsolescence in Appraisal Reports
Appraisers must substantiate their findings in their appraisal reports. Unfortunately, there isn’t one good way to address external obsolescence, which is why appraisers need to use an arsenal of tools for property valuation in these instances.
Best practices include meticulous documentation and supporting evidence. Be transparent in explaining the impacts affecting value. Including documented changes, such as historic photos or zoning changes, will help substantiate your findings.
It’s important to stay current with market and environmental changes and trends in the area where you work. While you don’t need to be an expert in land use planning or attend zoning commission meetings, it is important to be aware of changes in the community.
Case Studies and Examples
External obsolescence occurs when the property owner has no “cure”—the condition is uncurable or cannot be remedied. This occurs when the property’s highest and best use changes. Here are a few examples:
An exiting residential home adjacent to a newly built landfill. Undoubtedly, it’s not everyone’s dream to live near a landfill. There are numerous environmental concerns with landfills on top of noise and air pollution. This is an incurable condition for the property owner. The highest and best use for properties adjacent to landfills include warehouses and industrial parks.
A depressed economy resulting from a local factory shutdown. When large factories shut down or relocate, they often leave a ghost town in their wake. It can take years for towns to recover due to things like environmental cleanup and redevelopment.
An older home in a neighborhood experiencing tremendous commercial growth. Commercial development creates noise pollution, increased traffic, and loss of residential charm. The best use of properties near commercial centers might include multifamily apartments, business parks, or other retail.
The Role of Continuing Education
Appraisers should stay up to date with current trends impacting external obsolescence and how to handle those in an appraisal. The best way to do that is to maintain a pulse on the local economy where you work and stay current with continuing education.
Learning new evaluation methods or how to evaluate challenging properties or niche properties can equip the appraiser with information to draw from when faced with functional obsolescence. Just two of many courses offered by McKissock that can add tools to your toolbelt the next time you’re faced with a property that’s affected by external obsolescence include:
McKissock’s Market Disturbances-Appraisals in Atypical Markets and Cycles emphasizes how to appraise properties impacted by environmental disturbances such as hurricanes and fires. It also covers housing bubbles and bursts.
The Complex Properties: The Odd Side of Appraisal course covers complex and non-conforming properties and demonstrates how to use different appraisal techniques, and creativity (e.g., use of non-traditional appraisal techniques) to solve appraisal problems.
Conclusion
External obsolescence can have big consequences on property values. These factors are typically uncurable and result in a change to the highest and best use of a property. For the appraiser, they present a unique challenge as no one appraisal method exists to adequately evaluate external obsolescence.
One thing appraisers can do is keep a pulse on their market and stay current with continuing education. McKissock’s membership is the best way to learn. All the courses are available to you, like the Market Disturbances and Complex Properties courses.
McKissock’s new dashboard keeps everything organized and lets you know how you’re doing with your required and elective courses throughout the year. We’re always here to answer any questions you have.
