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Published by OREP, E&O Insurance Experts | August 13, 2013 | Vol. 284

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Estimating Functional Obsolescence
by Philip G. Spool, ASA

When was the last time you indicated a functional obsolescence in the cost approach?  Did you also reflect it in the sales comparison approach? Would you? Should you?  These are questions we rarely, if ever, consider. Perhaps we even avoid the issue when we think the house we are appraising has functional obsolescence.

In order to prepare for this article, I read and re-read many appraisal books regarding functional obsolescence and how it is determined.  The more I read, the more I realized how complicated it can be. You will notice that some of my sentences end with a question mark (?). This is because functional obsolescence is probably the most complicated obsolescence to calculate mathematically, and so, I question whether it is really necessary to do any calculations at all. Here’s what I mean.

What is Functional Obsolescence?

According to the Dictionary of Real Estate Appraisal, Fifth Edition (Appraisal Institute), functional obsolescence is “the impairment of functional capacity of a property according to market tastes and standards.”  The Appraisal Institute’s (AI) book The Appraisal of Real Estate - Thirteenth Edition states, “Functional obsolescence may be caused by a deficiency or a superadequacy.  Some forms are curable and others are incurable.”

Does this mean that as appraisers we insert our interpretation and opinion as to whether a property has functional obsolescence or is it determined by the potential buyer of a property?  In my opinion, the answer is yes to both. The potential buyer of a property ultimately determines whether or not a property has functional obsolescence.  Also, any person with experience in the real estate market can possibly determine if the property has functional obsolescence by observation. However, determining the dollar amount of the obsolescence is another issue.

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Types of Functional Obsolescence
Functional obsolescence is the result of defects within a property. This may be in the building, the building itself, or on the site but not in the building.  It may be the result of a superadequacy or a deficiency.  It may be curable or incurable.  There are two types of functional obsolescence: superadequacy and deficiency.  A superadequacy is something that exceeds what is typical for the properties in the area and does not contribute to the overall value in an amount equal to its cost.  A deficiency is basically the lack of something that other properties in the subject’s neighborhood have.  A superadequacy or deficiency can be either curable or incurable.

Examples of Functional Obsolescence

A superadequacy can include an overimprovement to the structure.  An example would be a house in a relatively new development that the builder used as a model, including many extra features that are not in other houses. It could be converting an adjoining bedroom for purposes of creating an oversized walk-in closet for the master bedroom or making it into one very large master bedroom- something that is not typical of the other houses in the area. There are many other examples. A superadequacy is typically associated with features that are above and beyond what is considered normal for the neighborhood.

A deficiency can be too few bathrooms given the number of bedrooms, or the lack of a bathroom that has easy access to a swimming pool (sometimes referred to as a cabana bathroom).  It can be a house that has wall air conditioning units instead of central air. If a property requires an addition in order to be functional or if the property requires some form of modernization or renovation(s), such as a new kitchen, bathrooms or flooring, these are examples of a deficiency. What about a poor floor plan?  An example of a poor floor plan is a bedroom that can only be accessed through another bedroom. More than likely this would be a deficiency. There are many other examples.  A deficiency is associated with the lack of features that are associated with what is typical in the area.

Curable or Incurable

The key difference between curable and incurable functional obsolescence is whether the cost to cure results in an incremental increase in value. If it does it is considered curable.  An example of curable functional obsolescence would be if renovating a kitchen would result in an increase in the overall value of the house greater than the cost to renovate the kitchen.  Most curable functional obsolescence are deficiencies.  An example of incurable functional obsolescence (deficiency) would be if the cost to add an additional bathroom exceeds the incremental value it would gain by adding it, especially if there is no space available for the additional bathroom.  However, if adding the additional bathroom generates more value than it costs, then it would be considered a curable functional obsolescence (deficiency). Think of a four-bedroom/one bath house versus a four-bedroom/two bath house as an example.

A superadequacy in a house may be an oversized swimming pool or a custom kitchen that is not typical of the neighborhood. The cost to cure would be the cost to remove the existing superadequacy (oversized swimming pool or the custom kitchen) and replacing it with a standard size swimming pool (typical 15' x 30') or a non-custom kitchen.  Both of these are examples of an incurable functional obsolescence (superadequacy).  It would be an extremely rare situation for a superadequacy to be curable- there are none that I know of.  It is more likely that the sale of the house with a superadequacy would not generate an amount equal to what it cost.

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Calculating Functional Obsolescence in Cost Approach
Regarding a functional obsolescence deficiency that lacks something, the calculation is the difference between the reproduction cost with the curable item and without it, as of the date of appraisal.  Note that this is reproduction cost and not replacement cost. Functional obsolescence is the excess cost of adding the item in question, such as an additional bathroom or the new kitchen, to the existing house compared to what it would have cost at the time of construction.  Since it is an added item, only the cost new is utilized.  Regarding a functional obsolescence deficiency that requires modernization (kitchen, bathroom or flooring), the cost to cure is based on the same principle as above, with the exception that the depreciated cost of the existing item must be deducted as most likely it will not be salvageable. 

Regarding a functional obsolescence superadequacy (most likely incurable), if the appraiser calculates the replacement cost in the cost approach, the functional obsolescence is eliminated.  In regard to the oversized swimming pool or a custom kitchen in a neighborhood not needing a custom kitchen, it would be the cost to eliminate or remove the existing item and replace it with an item considered acceptable for the area.  But this would be ludicrous because unless the superadequacy causes additional expense (heating an oversized swimming pool for instance), the appraiser would not do any calculation for functional obsolescence- superadequacy.  Again, if the appraiser considers replacement cost new of the swimming pool, it would be a typical size pool and not the oversized swimming pool.

An alternative approach to measure functional obsolescence would be to apply the rent loss difference between the house with the deficiency (i.e. the monthly rental rate of a four-bedroom/one bath house versus an acceptable four-bedroom/two bath house), and then apply the gross monthly rent multiplier to this rent loss, attributable specifically to this deficiency. This is also difficult to do but is certainly better than trying to perform a paired sales analysis to compute the functional obsolescence.

How is Functional Obsolescence Treated in Sales Comparison Approach?

FannieMae Form 1004 has line items regarding Design, Quality of construction and Functional utility.  An adjustment for any of these line items is difficult to determine.  All textbooks lean toward using a paired sales analysis. This is easier said than done. Design is based on the style of the house, such as a one-story versus a two-story or a ranch house versus colonial or Mediterranean.  This may be a matter of preference or taste, unless the subject’s design is out of place for the neighborhood.  A good example of this would be a two-story house in a predominately one-story neighborhood. 

Note that quality of construction should not be confused with condition of the building.  A good example of quality of construction is different roofing materials.  A house with a slate or cement tile roof would probably be considered superior to an asphalt shingle roof.  Sometimes the quality is based on the cost differential between the two materials, but again, in this situation, cost does not equate to a difference in value.  Functional utility is probably the best location to place an adjustment for functional obsolescence, but how can it be quantified?

Calculating Functional Obsolescence in Sales Comparison Approach (or do you?)

Functional obsolescence as a form of depreciation is not calculated in the sales comparison approach, only in the cost approach.  Functional obsolescence is “hidden” in adjustments in the sales comparison approach, such as outdated kitchens, bathrooms, old style wallpaper and carpeting (remember shag carpets?).  Line adjustments made in the sales comparison approach, for design, condition, etc. are, in essence, adjustments for functional obsolescence, but it is not referred to as such in the sales comparison approach. There is no line item for poor floor plan, superadequacy or deficiency.

Even though calculating the functional obsolescence of the subject is plausible, the purpose of the sales comparison approach is to compare the subject with sales of properties similar to it; any difference between the subject and the comparable sales would reflect an adjustment.  A comparable sale would reflect the functional obsolescence in its sales price. 

Other than the obvious, such as too few bathrooms given the number of bedrooms (four-bedroom/one bath house), how would you know if the comparable sale has functional obsolescence unless you either appraised the property or have first-hand knowledge of it?  Most likely you wouldn’t.  Design, quality of construction and functional utility, which was briefly discussed above as possible functional issues, cannot be determined in the comparable sale unless the appraiser has first-hand knowledge of that property. Any adjustment you intend to make regarding functional obsolescence to the comparables, in comparison to the subject, is almost impossible to support.

Instead of trying to calculate the amount of functional obsolescence in the sales comparison approach, consider going toward the lower end of the range in your adjusted sales price when reconciling and state why you went toward the lower end of the range.  One explanation you can give is to recognize that, more than likely, functional obsolescence exists in your subject property which would make the comparable sales superior to the subject, but that quantitative adjustment is difficult to support, therefore, a market value closer to the lower end of the range would be considered appropriate.

In conclusion, if your subject property has functional obsolescence, an adjustment for it in the cost approach could be made and supported. But it is difficult and nearly impossible to support an adjustment for functional obsolescence in the sales comparison approach, as the only logical method to use would be the rent loss method. This would require rental comparables for the subject with the functional obsolescence compared to a rental without the functional obsolescence - a near impossibility.

About the Author

Philip G. Spool, ASA, is a State-Certified General Real Estate Appraiser in Florida, appraising since 1973.  Formerly the Chief Appraiser of Flagler Federal Savings and Loan Association, he has been self-employed for the past 20 years. In addition to appraising, he is an instructor with Miami Dade College, teaching appraisal courses and continuing education.  He is Vice President and Chairman of Real Estate Programs with the Greater Miami Chapter of the American Society of Appraisers.  He can be reached at

Mobile Appraising Training Package: Increase your efficiency and the quality of your reports. You are busy appraising but are you making more money? See how the experts maximize their time and effort using mobile tools. Enjoy at your own pace, when it's convenient for you. (Includes eBook, Training Video and Webinar.) Click to learn more.

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