First things first-what is it? External obsolescence refers to the depreciation of a property’s value due to factors outside the owner’s control.
Unlike physical deterioration or functional obsolescence, which stem from issues within the property, external obsolescence is caused by external changes in the surrounding environment, economy, or regulatory landscape.
For commercial properties, this could mean a once-thriving retail strip losing its allure because of a new bypass diverting traffic. These factors often impact a wide range of properties in the area, making external obsolescence a shared challenge rather than an isolated issue.
How Does External Obsolescence Differ from Functional Obsolescence?
While both external and functional obsolescence lead to property depreciation, their causes and remedies differ significantly:
- External Obsolescence: As mentioned, this stems from forces beyond the owner’s control, such as economic downturns or new government regulations. For instance, a tax increase in a commercial zone might reduce the profitability of owning property there.
- Functional Obsolescence: Arising from outdated or inefficient property features that no longer meet market demand. Examples include office buildings with insufficient parking or retail spaces without ecommerce adaptability.
Naturally, the distinction is critical for appraisers and investors. While functional obsolescence can often be mitigated through property upgrades, external obsolescence typically requires broader market shifts or community-wide efforts to reverse.
Common Causes of External Obsolescence
Since external obsolescence only comes up when outside forces erode the value of commercial real estate, the causes at fault can be numerous. Unlike internal property issues, these factors often affect entire neighborhoods, cities, or regions, creating widespread challenges.
The Impact of External Obsolescence on Property Value
External obsolescence doesn’t just chip away at property value—it can create a domino effect that impacts every facet of ownership and profitability. Here are the key ways it manifests in commercial real estate:
Rental Income Drops – As external factors drive tenants away, landlords often face prolonged vacancies or must reduce lease rates to stay competitive. Take the example of a suburban retail strip that loses foot traffic after a nearby mall introduces a new entertainment wing—it’s hard to fill storefronts when customers are lured elsewhere.
Resale Value Plummets – When external forces devalue a property, its appeal to buyers diminishes. A commercial building adjacent to a newly built landfill, for instance, might struggle to attract offers, leaving owners with diminished bargaining power.
Financing Challenges – Lenders see properties affected by external obsolescence as riskier investments. Owners may encounter higher interest rates or outright loan denials, further squeezing their ability to reinvest.
The cumulative effect often feels like a downward spiral, but recognizing these impacts early can help owners plan responses before the damage becomes permanent.
How Appraisers Account for External Obsolescence
Understanding how appraisers evaluate external obsolescence can demystify the valuation process for commercial property owners. While appraisals can feel like a black box, the methodologies behind them are designed to reflect external realities accurately.
- Market Comparisons: Appraisers often start by comparing the property to similar ones in the same region. If other office parks in the area have also experienced rising vacancies due to infrastructure shifts, this trend will factor heavily into the valuation.
- Income Adjustments: An appraiser might also consider future earning potential. For example, if a retail center’s foot traffic plummets due to a nearby bypass, projected rental income will likely be reduced, and the value adjusted accordingly.
- Cost-to-Cure Analysis: In rare cases where remediation is feasible, appraisers will estimate the expense of addressing external obsolescence. For example, they may assess whether installing noise-reduction barriers near an industrial property could restore some lost value.
Appraisers focus on providing an unbiased, data-backed view, helping property owners and investors make informed decisions.
Can External Obsolescence Be Reversed?
Reversing external obsolescence isn’t always possible, but it can happen under the right circumstances. Sometimes, all it takes is a shift in market trends or creative thinking from property owners.
Take, for instance, a warehouse that loses tenants after a nearby highway is rerouted. On the surface, it seems like a permanent loss. But with the rise of ecommerce, that same warehouse could transform into a highly desirable last-mile delivery hub.
Other scenarios might require outside intervention. Coastal commercial properties threatened by rising sea levels could regain their appeal with government-funded seawalls or flood prevention systems. Similarly, communities affected by zoning changes or blighted areas may see revitalization through tax incentives or redevelopment grants.
What Are the Early Warning Signs of External Obsolescence?
External obsolescence rarely happens overnight. Instead, it often gives off subtle warning signs that property owners and investors can detect if they know what to look for. Recognizing these indicators early can help mitigate potential damage:
- Declining Traffic Patterns: If fewer cars or pedestrians frequent the area, it might signal reduced desirability. A shopping plaza near a highway rerouted to bypass the area is an example where footfall may steadily decline.
- Tenant Turnover: High tenant turnover or extended vacancies in nearby properties can hint at growing external challenges like market saturation or demographic shifts.
- Negative Local News: Watch for reports of zoning changes, tax hikes, or major employers downsizing, as these can indirectly impact property values.
Early detection allows property owners to proactively adjust strategies, like diversifying tenant types or choosing to lobby against harmful zoning changes.
Real World Example: Rolling Hills Mall
The rise of e-commerce has profoundly impacted traditional retail environments, leading to widespread external obsolescence in shopping malls. A notable example is Rolling Acres Mall in Akron, Ohio.
Rolling Acres Mall: A Timeline
- Opening and Expansion: Opened in 1975 with Sears as the primary anchor, the mall expanded rapidly, adding anchors like JCPenney, Montgomery Ward, and O’Neil’s. At its peak, it housed over 150 stores.
- Decline in the 1990s: The 1990s saw a sharp decline in tenancy, attributed to the growth of online shopping and changing consumer behaviors. Anchor stores began closing, leading to reduced foot traffic and further tenant losses.
- Closure and Aftermath: By 2008, the mall and its remaining anchors had closed, and by the 20-teens, the property was eventually demolished. In 2020, Amazon opened a distribution center on the site. Is there a better example of the shift from traditional retail to e-commerce? Probably not.
Lessons Learned
Rolling Acres Mall’s trajectory illustrates how external factors like technological advancements can render retail properties obsolete. The mall’s inability to adapt to the ecommerce boom led to its decline and eventual repurposing. This case underscores the importance for property owners to anticipate market shifts and consider adaptive reuse to mitigate external obsolescence.
How Zoning Changes Contribute to External Obsolescence
Zoning regulations play a powerful role in shaping the value and utility of commercial properties, but changes to these regulations can inadvertently lead to external obsolescence.
For instance, consider a suburban office park that was originally surrounded by other commercial developments. A rezoning decision permits industrial use in the area, leading to the construction of large manufacturing facilities nearby. The resulting increase in noise, truck traffic, and industrial activity makes the office park less appealing to tenants, driving vacancies and reducing rental income.
Incompatible neighboring land uses, like industrial facilities next to office spaces, create an environment where businesses no longer see value in remaining. Property owners caught off guard by these zoning changes often find themselves with devalued assets and limited options. Engaging in local planning discussions and staying informed about proposed rezoning efforts can be critical in avoiding outcomes like that.
What Happens When External Obsolescence Affects a Whole Market?
External obsolescence doesn’t just affect individual properties—it can ripple across entire markets. When this happens, once-thriving areas can be turned into underperforming sectors. Consequences stemming from market-wide changes can reshape entire commercial real estate ecosystems, as well as the regions themselves!
Take the example of the Rust Belt in the United States. Cities like Detroit, Cleveland, and Pittsburgh were heavily reliant on manufacturing industries that began declining in the late 20th century. As factories shuttered and jobs moved elsewhere, the demand for industrial and office space collapsed. Entire neighborhoods of commercial properties became vacant, causing property values to plummet. This domino effect extended to ancillary businesses like retail stores and restaurants. No people = no revenue for businesses.
Unfortunately, the effects of market-wide external obsolescence are often long-lasting. Recovery typically requires coordinated efforts from local governments, private investors, and community organizations to introduce new industries or repurpose affected properties. Without these interventions, property owners face prolonged depreciation and ongoing vacancies, turning entire markets into economic dead zones.
Quantifying External Obsolescence: What Appraisers Look For
Appraisers play a vital role in identifying and quantifying the impact of external obsolescence, ensuring that property valuations reflect reality. While the process can be complex, appraisers rely on specific tools and methodologies to measure how external factors influence value.
- Market Comparisons:
Appraisers analyze similar properties in the same region to detect trends. For example, if a group of office parks in a downtown area shows declining lease rates due to a major employer relocating, this pattern helps quantify the external obsolescence. - Income Capitalization Adjustments:
When external factors reduce a property’s ability to generate income, appraisers adjust the valuation accordingly. For instance, a retail center losing foot traffic to a new highway bypass might see lower projected rental income, which directly impacts its market value. - Cost-to-Cure Analysis:
In some cases, appraisers evaluate the feasibility of mitigating the external obsolescence. This involves estimating the costs of adaptations, such as installing soundproof barriers near properties impacted by noise pollution, and weighing those costs against the potential recovery of value. - Environmental and Legal Reviews:
External obsolescence often stems from changes in zoning, new environmental risks, or legal restrictions. Appraisers review these external forces and document their tangible impacts on property desirability and market performance.
Through these methodologies, appraisers provide data-driven insights that help property owners, investors, and lenders understand the true value of their assets, guiding decision-making in challenging market conditions.
Strategies to Mitigate External Obsolescence in Commercial Properties
While external obsolescence is often seen as beyond an owner’s control, there are practical strategies to mitigate its effects. One effective approach is diversifying the tenant mix. Properties overly reliant on a single type of tenant or industry are particularly vulnerable to market shifts.
For instance, a retail strip center that includes essential businesses like grocery stores and medical offices is less likely to be impacted by a downturn in discretionary retail than one dominated by apparel stores. Diversification ensures a steady flow of income even if one segment of the market struggles.
Engaging in local planning discussions is another proactive measure. Property owners who stay informed about zoning changes or proposed infrastructure projects can anticipate potential risks and influence outcomes that align with their property’s interests. Stay informed! Cities also frequently offer incentives like tax breaks or grants for revitalization efforts, which can offset the cost of upgrades and repositioning.
Why Do Some Properties Adapt Better to External Obsolescence Than Others?
Not all properties are equally affected by external obsolescence, and certain characteristics make some properties more resilient than others. Location plays a critical role in determining how well a property can adapt. Commercial spaces situated near major transit hubs or in diverse economic regions often have built-in flexibility.
For example, an office building near a metropolitan train station can attract a wide range of tenants, even as demand shifts. In contrast, properties in remote or single-industry areas face far greater challenges when external factors disrupt the market.
The design and layout of a property also contribute to its adaptability. Buildings with flexible, open-floor plans are more likely to find new uses. A warehouse with modern features, such as high ceilings and advanced docking systems, can seamlessly transition into a last-mile delivery hub, while older facilities with fixed layouts may struggle to meet new requirements. Design versatility is especially crucial in areas experiencing rapid technological or industrial changes.
Proactive management is another critical factor. Property owners who stay ahead of market trends and pivot quickly are better equipped to weather external challenges. This level of responsiveness often separates successful adaptations from prolonged vacancies.
In the end, the ability to adapt is less about luck and more about foresight, design, and strategic management. Properties with these strengths not only endure external pressures but can thrive in changing markets.
Is External Obsolescence Always Permanent? Analyzing Recovery Trends
External obsolescence is often viewed as irreversible, but recovery is possible under the right circumstances. The permanence of its effects depends on the external factor in question, as well as and the measures taken to address it. For example, economic downturns that initially depress property values can rebound with market recovery.
Consider Pittsburgh, Pennsylvania: once heavily reliant on the steel industry, the city faced widespread economic decline and property devaluation after the collapse of the steel market in the 1980s. However, through strategic efforts—such as attracting technology companies, investing in healthcare, and creating tax incentives for new businesses—Pittsburgh successfully revitalized its economy and commercial real estate market.
Community revitalization projects also play a significant role in reversing obsolescence. Coastal cities at risk from rising sea levels, for instance, may recover through the construction of protective infrastructure like seawalls. Similarly, mixed-use redevelopments can transform blighted commercial districts into vibrant, multi-functional spaces. However, some causes, such as permanent shifts in consumer behavior or environmental degradation, may leave properties stranded without long-term interventions.
The key takeaway is that while external obsolescence can be daunting, it isn’t always a death sentence. With proactive measures and strategic planning, many properties and markets can recover, regaining their value and utility over time.
How External Obsolescence Shapes Future Development Patterns
External obsolescence doesn’t just affect current properties—it also influences how developers approach future projects. Developers increasingly consider resilience and adaptability as core design principles. For example, new retail spaces often emphasize flexibility, incorporating areas that can easily be converted into warehouses, medical offices, or recreational spaces if market conditions shift.
Urban planners, too, are rethinking zoning and infrastructure to accommodate evolving economic and environmental realities. Mixed-use developments, which combine residential, commercial, and recreational spaces, have grown in popularity as they reduce the risks of overreliance on any one sector. A suburban mall built today is more likely to include apartments or green spaces than rely solely on traditional retail tenants.
Developers are also taking sustainability into account. Climate-conscious designs, such as flood-resistant buildings or energy-efficient structures, mitigate the risks of environmental obsolescence. These forward-thinking approaches ensure that properties remain viable, even as external forces continue to evolve.
Can Technology Reduce External Obsolescence in Commercial Real Estate?
Technological advancements are playing a growing role in combating external obsolescence. Smart buildings, for instance, can adapt to tenant needs with features like flexible lighting, automated HVAC systems, and customizable floor layouts. These innovations not only enhance tenant satisfaction but also make properties more versatile, allowing them to attract a broader range of occupants.
PropTech (property technology) platforms are also helping property owners identify potential risks earlier. Data analytics tools can track trends in tenant behaviors, local demographics, and market conditions, enabling owners to adjust strategies before obsolescence takes hold. For example, predictive algorithms might flag declining foot traffic in a retail area, prompting owners to diversify their tenant mix proactively.
Beyond individual properties, technology supports larger market adaptations. Virtual tours, digital marketing tools, and remote leasing platforms make properties more accessible to tenants worldwide, reducing dependency on local demand. These technological shifts are redefining how properties are managed and marketed, helping owners stay competitive in a rapidly changing environment.
Goodbye Anchor Stores: Losing a Major Tenant on Surrounding Properties
The closure of major tenants like Sears and Macy’s demonstrates the cascading impact of external obsolescence on surrounding properties. When Sears filed for bankruptcy in 2018, it closed over 140 stores, many of which served as anchor tenants in shopping malls. These closures didn’t just leave large vacancies—they reduced foot traffic for smaller stores, restaurants, and service providers that relied on the draw of the anchor tenant.
Consider the Highland Mall in Austin, Texas, which suffered when its anchors closed, leading to declining occupancy across the board. The surrounding businesses, from convenience stores to local restaurants, also experienced revenue losses as fewer visitors frequented the area. Eventually, the property had to be completely redeveloped into a multi-purpose campus featuring education facilities and office spaces, illustrating how significant reinvestment is often needed to counteract the ripple effects of tenant closures.
How Global Trends (e.g., Climate Change, Remote Work) Drive External Obsolescence
Global trends are reshaping commercial real estate in unprecedented ways. Climate change, for example, is rendering coastal properties vulnerable to rising sea levels and extreme weather, forcing property owners to rethink their long-term strategies. Similarly, demographic shifts and urbanization are redirecting demand toward mixed-use developments in walkable cities, leaving older suburban office parks struggling to remain relevant.
Remote work is another major disruptor. As companies downsize their office footprints, traditional office buildings face mounting vacancies. Entire business districts in major cities are seeing declines in foot traffic, reducing demand for retail and service spaces that once thrived on corporate employees.
These trends emphasize the need for adaptability in property management and development. Owners who anticipate shifts—whether through incorporating sustainable designs or reimagining office spaces—are better positioned to weather the changes, while those who ignore them risk obsolescence.
Conclusion
External obsolescence is an ever-present challenge in commercial real estate, driven by forces beyond any individual owner’s control. However, understanding its causes, identifying early warning signs, and implementing proactive strategies can mitigate its impact and even create opportunities for recovery and reinvention.
If you’re a business owner that stays informed and adaptable, property owners can work through the challenges of external obsolescence while positioning their assets for future success.
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