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Real Estate Investing with Functional Obsolescence in Mind

by John Fedro on April 3, 2010 · 4 comments

  
real estate investing functional obsolescence

Common sense and proper real estate investment training teach us to preform due diligence before entering into a purchase agreement with a seller.  Good real estate investors are taught to determine Loan to Value (LTV), After Repaired Value (ARV), Repair Cost (RC) and Maximum Allowable Offer (MAO).  These abbreviations, numbers and percentages allow us to assign an estimated value to a property compared to other homes of similar size, features and area.  With these numbers it is now possible for most of us to formulate a general idea of the current value of the home.

Experienced investors know that a property is not worth a penny until someone pays you for it.  You can’t eat equity. This post is on a subject I had to learn the hard way.  Functional obsolescence is defined as the impairment of the usefulness of a device or equipment due to a design defect. Anything that causes the majority of your potential buyers to pass on your property may be cause for alarm.

Do not get stuck with an investment property you can’t sell because of functional obsolescence.  A home that is functionally unusable or severely out of date may take “XX” extra months to sell, thousands more in holding costs, and thousands discounted off the sales price versus a functionally sound home.

Here are a few things to watch out for:

  1. Outside washer/dryer: Many homes built in the middle of the 20th century were built with an outside area to wash and dry clothes.  Assume that if you purchase these homes you will need to figure out some way to turn the modern convenience of inside washing and drying clothes to reality.
  2. Major road: Living and raising kids on the side of a major road is not many American’s idea of happiness.  The roadway may be a new city project or the result of a population growth over-time; either way the populated major road will lower the functionality of a home and its enjoyment/use.  A mentor of mine told me to lower the estimated value by 40% if a property sits aside a busy roadway.
  3. Odd bathroom out: I remember looking at a mobile home that was originally a 3 bedroom 2 bathroom home.  It was recently converted into a very spacious 2 bedroom 1 bathroom mobile home.  The second bathroom and 2 smaller rooms were all demolished and combined to make 1 “super-room”.  The only problem is if anyone has to use the bathroom they would have to walk through the master bedroom, or go outside.  Who in their right mind will buy a home like this? I did, and for a brief time I was happy.  This property took months to sell and was a tremendous pain in my rear.  However, this is a great story for another post.   Remember, the biggest rooms in the world will not help sell a house with an idiotic floor plan.

In the end, any structural problems or unorthodox characteristics that make the majority of your potential tenant/buyers not desire your property is a cause for concern.  If a home is functionally obsolescent, do not discard the potential deal.  Price cures all. If the home is functionally ugly and obsolete, make a low offer. Stay firm to your price, use this functionally problem to your advantage and get the best terms and lowest price possible.

- J. fed

Photo: jitze

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{ 4 comments… read them below or add one }

Tod April 3, 2010 at 11:32 pm

This is great advice. I think a lot of people don’t factor obsolescence into purchasing decisions. Despite real estate investment being a business decision, so many people still get caught up in the emotion of it all.

Tod Maffin

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John April 6, 2010 at 12:33 pm

Tod,

Absolutely, I think we can all agree that investors and end-users look at property through 2 very different sets of eyes. And emotion plays a large part to many end-users. thanks for the comment.

John

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Liz Voss with San Antonio Real Estate April 5, 2010 at 10:53 am

Well said John. Sometimes the new investor becomes emotionally attached to their investment, and will either pay to much for the real estate, or under estimate the amount of repairs needed. That doesn’t even take into consideration of any previous conversions such as your mobile home.

Visit Liz Voss’s last blog at San Antonio Homes.

Reply

John April 6, 2010 at 12:35 pm

Lol! I know I have learned that lesson once of twice before. john

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