FUNCTIONAL OBSOLESCENCE
Functional obsolescence is a loss in value caused by a flaw in the structure, materials or
design of the machinery, equipment or real property improvement when compared with the highest
and best use and most cost-effective functional design requirements at the time of appraisal.
Most types of functional obsolescence involve excess capital costs (caused by a super
adequacy) or excess operating expenses (caused by a deficiency).
ECONOMIC OBSOLESCENCE
Economic obsolescence is a loss in value caused by a negative influence that is external to
the subject property. Most of the time this loss in value is incurable. Examples of these external
negative influences may be an oversupplied market or proximity to an environmental disaster.
BEST WAY TO DETERMINE IF OBSOLESCENCE EXISTS
Just because a property is operating at less than design capacity does not mean that
obsolescence exists. No property will operate at 100% of capacity 100% of the time. There are
always seasonal fluctuations, peak periods and lag periods, downtime for maintenance, etc.
Properties, ideally, would run at optimum capacity or the capacity that allows the owner to achieve
his/her investment goals. This requires an economic analysis. The best way to determine whether
any form of obsolescence exists with the subject property is to perform a proper income approach
to value for the subject property. This would require estimating future operating revenues and
future operating expenses associated with the subject property and converting these estimates of
future cash flows to a present value through the use of a weighted average cost of capital.
