Locational obsolescence is a type of depreciation on a real estate property that is caused by factors other than the property itself. The factors can either be environmental or other external factors that occur in the property’s location.
For example, the establishment of an industrial plant in the neighborhood can result in noise pollution, waste dumping, and untreated fumes, which can adversely affect the residents living in the neighborhood. As a result, the presence of the industrial plant in the same location as the property causes low occupancy rates, resulting in a decline in the value of properties in the neighborhood.
Locational obsolescence occurs due to factors that surround the property.
The loss of property value is exerted on the property by external forces and environmental changes in its surroundings.
Locational obsolescence is also known as external or environmental obsolescence.
External Factors that Affect Locational Obsolescence
External factors may also affect property valuations. For example, areas with a high crime rate are less attractive to investors, since most people shy away from buying properties in such location. Other factors, such as a struggling job market and unfavorable business environment in a given location, can result in loss of value. Potential investors will find it difficult to raise enough capital to buy properties in that location.
External factors that contribute to locational obsolescence are incurable on the part of property owners and tenants. This is because the investors don’t exercise control over such factors or it would be too expensive for them to find a solution to the existing problems.
For example, when major employers close down their businesses in a given location, the property owners will suffer from low occupancy rates and rent defaults, and there is nothing much they can do to restore the situation to how it was before. External factors diminish the returns on real estate investments, resulting in significant loss of value.
Environmental Factors that Affect Locational Obsolescence
The surrounding environment of a real estate investment can cause an increase or decrease in the value of a property, depending on the changes that occur in the neighborhood. The environment is bound to change constantly. For example, opening a landfill in the neighborhood may result in a decline in the value of properties in the neighborhood, and the property owners may not be able to control the changes.
The changes in value due to environmental factors exerted on a property can be measured by determining the difference in income caused by such changes. The loss in income can be evaluated using the sales comparison method. The sales comparison approach uses recently sold and similar properties in the same location. It then harmonizes the values of at least three comparable and similar properties depending on the differences evident between the subject and the comparable properties.
The location of a property determines the value of that property to a large extent. Properties located near the main transportation channels tend to attract better prices than otherwise inaccessible locations. Properties near social amenities, such as schools, shopping malls, and hospitals, tend to be valued higher than otherwise remote properties because investors do not want to incur additional costs to access the amenities.
Examples of Locational Obsolescence
Building a property close to busy roads subjects the residents to traffic congestion, which may disrupt the travel schedules of most residents. Busy residents avoid such areas and this results in low demand for homes in specific locations. The high traffic also causes noise and air pollution, due to the presence of many vehicles on the roads, which may be a health hazard to the residents. Such factors lower the appraisal value of properties in that location, contributing to locational obsolescence.
Setting up commercial properties in a residential area also contributes to declining property values. Commercial buildings may accommodate different types of businesses, such as restaurants, casinos, night clubs, etc. The establishments may expose residents to high noise levels, which may cause tenants to vacate the neighborhoods.
The location of a property determines the best use of the property. For example, investors are attracted to high-end neighborhoods due to the controlled development in the area, as well as close proximity to a road network, airports, beaches, central business districts, etc. Any factors that affect the livability in such locations can easily push residents away and lower property values.
The effects of locational obsolescence are incurable, since the influences do not arise from within the properties and residents exert minimal control over them. The loss of value as a result of locational obsolescence can be determined by a valuation exercise.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:
Take your learning and productivity to the next level with our Premium Templates.
Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI's full course catalog and accredited Certification Programs.
Already have a Self-Study or Full-Immersion membership? Log in
Access Exclusive Templates
Gain unlimited access to more than 250 productivity Templates, CFI's full course catalog and accredited Certification Programs, hundreds of resources, expert reviews and support, the chance to work with real-world finance and research tools, and more.