What is the difference between functional and external obsolescence?

The distinction between functional obsolescence and external obsolescence is critical in real estate appraisal. Functional obsolescence refers to the loss in property value due to design flaws or inadequacies within the property itself. This could include elements such as outdated layouts, insufficient square footage for modern needs, or other features that are no longer considered desirable or functional. Essentially, it reflects a property’s inability to meet current market demands due to its design.

External obsolescence, on the other hand, arises from external factors affecting the property, such as changes in the surrounding environment or market. This could include negative influences like the rise of nearby polluting industries, crime rates in the area, or changes in zoning laws. These factors are not related to the property itself but rather to its external environment and can significantly reduce its desirability and market value.

Understanding this differentiation helps appraisers and investors assess the health of a real estate investment, allowing them to make informed decisions based on the nature of value loss—whether it's internal to the property or influenced by external conditions.