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The good news about obsolescence

Recently after finishing a plate of moo goo gai pan at my favorite Chinese restaurant, I broke open my fortune cookie and read the following: "The good news is, things are never as bad as they seem; the bad news is, things are never as good as they seem." Over the years I have found this principle generally true, especially in the area of property tax. Even if a building has flaws, those flaws may translate into property tax savings.

Virtually all property tax assessment systems, whether based on market value, reproduction cost or any other measure, embrace the valuation concept of obsolescence. Obsolescence comes in two flavors: economic and functional. Economic obsolescence relates to factors outside of the property that negate its value. Functional obsolescence relates to factors within the property, which decrease its value.

Either or both forms of obsolescence can be applicable in any given scenario and, if proven, can substantially reduce the assessed valuation of any commercial or industrial property. Although certain assessor friends might disagree, both forms of obsolescence can even apply to a brand new building. This article will discuss functional obsolescence only - its economic alter ego will need to await another day.

An illustrative example Whether your company owns office, retail or industrial structures, functional obsolescence arguments may well be available in an appeal context. Suppose your company has built a new corporate headquarters building. In planning the structure your CEO has mandated that the architecture be unique and reflect a modern corporate image. The end product is dazzling, with numerous cuts and curves, zigs and zags, and otherwise looks like something out of the Jetsons. How, you may ask, can such a new structure be obsolete anyway?

While the building may be an architectural wonder, the real question is whether it is functional and efficient. It was built to serve as a corporate headquarters, housing computer geeks, production planners, accounts receivable folks and various administrative personnel. While the top floor may house the executive suite, the balance of the building is occupied by employees who could do quite well with plain vanilla space.

Functionally, this building is obsolete the day it opens because the major function for which it will be used - housing garden variety administrative personnel - could well be accomplished in a much less expensive structure, and probably with much less square footage.

Defining functional obsolescence At this point, you may say, "All this sounds reasonable, but how do you measure this functional obsolescence?" The courts have accepted as the standard yardstick the appraisal approach of designing a replacement facility and comparing the value of the replacement facility to the cost of the subject structure. The key is to design a functional, low-cost building that can operate the same as a state-of-the-art facility. In this case, the projected cost of the replacement facility would be less than the actual cost of the completed project. The difference in cost may represent functional obsolescence.

But why stop there? The dramatic geometric design of your new facility has caused the architect to add an extra floor to house all administrative operations. Not only may the cost of the extra floor represent functional obsolescence, but there is an added operating expense of maintaining that space, including extra lighting, heating and lost employee time traversing the extra floors. All of those additional costs can be quantified and add to the obsolescence.

A second example Although this discussion has focused on a new state-of-the-art corporate headquarters, this analysis applies more forcefully in the case of industrial facilities. Suppose that your company's production facility operates out of a pre-World War II plant, which includes several buildings in the middle of the rust belt.

As in the case of our corporate headquarters, a replacement facility can be designed to carry out the same production process in an efficient and cost-effective manner. Even though your operations are in several buildings, those operations could be condensed into perhaps one large, single-story structure. The resulting reduced square footage translates into a functional obsolescence deduction.

In addition, operating costs could be reduced dramatically if a modern replacement plant were used. For example, transportation costs could be reduced because a work in process would need to travel fewer feet between production steps. This transformation results in a savings of fuel, forklift trucks, manpower and other costs. Heating and electrical costs could also be reduced if the production process were carried out in a modern, single-story structure, unlike our facility.

A similar analysis could be developed for any type of property. While proof of functional obsolescence may not be possible in every case, creative minds should visit this issue as the local tax appeal deadline begins to roll around. I believe it was Confucius who said, "He who fails to consider functional obsolescence may himself be functionally obsolete."

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