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How does real estate lose value?

From the Ground Up

Most real estate agents will tell you that the past few years have been the best in a long time for real estate. Average prices are higher than ever. On the other hand there are some sections where property values have gone down. Houses seem to stay on the market a long time. So how does real estate lose value?

Generally, real estate loses value in three ways. Depreciation is the loss of value from any cause. The depreciation can be either curable or incurable. Curable means that the cost to correct the item will result in a greater increase in the value of the property than the cost of the repair.

Physical deterioration is one cause of depreciation. It is simply a loss in value as a result of the physical elements of the property wearing out or needing repair. If a house needs painting, and it cost $1,000 to paint it, but the painting resulted in a $3,000 increase in value, then it would be considered to be curable physical depreciation.

Incurable physical depreciation is generally associated with long-lived items, such as floor and roof structures, mechanical systems and foundations. For example, a central air- conditioning system that needed replacement at a cost of $4,000, but only added $2,000 to the market value of the property, is considered incurable depreciation. The best way to avoid physical deterioration is preventive maintenance

The second way real estate loses value is through functional obsolescence. This is a loss in value due to a lack of utility or desirability of all or part of the property. One good example of functional obsolescence is the green and gold shag carpet that went out of style many years ago. Some other examples include inadequate lighting, out-of-date plumbing fixtures and poorly designed floor plans. One example of a poorly designed floor plan is the tandem bedroom, which is a house layout in which one has to go though one bedroom to get to another bedroom. A three-bedroom, one-bath house is also not considered very functional today, even though it might have been deemed such 30 years ago.

In today’s market a small master bedroom with no master bathroom would be considered functionally obsolete. Today’s buyers are often expecting master bathrooms as large as the master bedrooms. Functional obsolescence can even be found in new houses. Not long ago I saw a new condominium that had the master bedroom upstairs and the master bathroom downstairs. I would call that built-in functional obsolescence. Physical deterioration and functional obsolescence are losses of value that are on or in the property itself.

The third type of loss in value is external obsolescence. Also known as economic obsolescence, it is a loss in value caused by an outside force – something outside the boundaries of the property. Because it occurs off the property, it is often the most difficult to deal with.

Examples of external obsolescence are widening of a road that would increase the flow of traffic in the neighborhood, installation of a sewage treatment plant upwind of the property or a change in the character of the neighborhood, such as an increasing number of tenants. When these things occur, it is usually impossible for the owner to change them, thus the owner has little or no say-so in the effect on the value of his or her property.

It is wise to be alert to things going on in your neighborhood. If you learn of a potentially adverse occurrence, you may be able to stop it before it causes your property to lose value. Watch for things such as zoning changes, poor maintenance by public authorities, improper land uses and other items that might seem negative.

I recommend keeping up with the real estate market to learn about trends and influences on the value of real estate. One way to do this is to visit open houses and the annual Parade of Homes, sponsored by the local Homebuilders Association. You can get some great ideas on improvements to your home that will help it hold its value.

Phil Hardwick’s column appears regularly in the Mississippi Business Journal. His e-mail address is hardwickp@aol.com.


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