Functional Obsolescence: Why Take it Into Account

If you’ve lost power in your condo, it’s hard to imagine doing anything other than walking over to your utility closet, opening up your electrical panel, and flipping a switch in your circuit breaker. But for others living in older buildings, it may not be so easy to get power back. Some residential buildings built 30+ years ago are still equipped with fuse boxes. Fuse boxes are usually located in a common area, such as a hallway or a meter room. And unlike a circuit, a fuse will blow when overheated and will need to be replaced. Time to get strata to call an electrician! On the other hand, the internal mechanism of a circuit breaker will trip and shut off the power when there is a surge of electricity. Nothing gets burnt, so there’s nothing to replace. To restore power, you can simply reset the circuit breaker by flipping the switch back on. This makes a circuit breaker the preferred choice between the two, as it can be used over and over again. A fuse box is an example of functional obsolescence.

What is Functional Obsolescence?

You may have never heard of the term functional obsolescence, but there is a pretty good chance you might have seen it. Ever been to an apartment unit that has three bedrooms but just one bathroom? The textbook definition of functional obsolescence according to the Dictionary of Real Estate Appraisal is “the impairment of functional capacity of a property according to market tastes and standards.” Another common (and outdated) feature found in older properties is single-paned windows. There’s a slim chance you’ll find these in newer buildings, as double-paned (or even triple-paned) windows are now the norm due to their energy-efficient, noise-cancelling, and long-term cost-savings qualities.

An apartment unit with 3 bedrooms but only 1 bathroom is considered functionally obsolete as it does not meet current market expectations.

Functional Obsolescence and Insurance Appraisals

At Normac, our accredited appraisers use a Cost Approach to determine our replacement costs. Estimates are based on replacing a property with an equally desirable substitute, as close as possible to where the property stands now. In other words, we generally assume a like-for-like replacement of all components of the property. However, we must also consider what has changed since the original property was built. There are some circumstances—such as in the case of fuse boxes—where it is safe to assume that existing components within the property will be replaced with a similar alternative, one that is up to current industry and technology standards. Fuse boxes were not designed to deal with today’s electrical loads—they are considered functionally obsolete—and so replacing them with modern circuit breakers in the case of a total loss is a reasonable assumption.

We take functional obsolescence into consideration in this process because in most cases, it will cause the cost per square footage of the property to go down. During an appraisal, we try to estimate how much it would cost to replace the utility in the building rather than how much it would cost to reproduce the exact property.

Copper vs. PEX Plumbing

Copper pipes are: rigid, fire-resistant, recyclable.
PEX pipes are: low cost, bendable, easy to cut.

To illustrate this point, let’s take a look at copper vs. PEX (plastic) piping. Technology often changes the choice of construction materials. Two decades ago, copper piping was the gold standard of plumbing. It is a time-tested water supply line material with its list of pros, but that doesn’t mean that it’s immune to trouble. For one, copper pipes are more likely to break if the water inside freezes. Copper is also a very rigid material, which means it has to be cut and soldered to size, requiring more connections and thus more installation labour. Then there’s the issue of cost. Copper pipes will cost 58 to 68 per cent more to install than PEX pipes.

 

Conversely, due to its plastic nature PEX pipes can be installed 30 to 40 per cent faster than copper pipes. PEX is also known for its durability. When adjusted for pressure and temperature ratings, it has a predicted life expectancy of 50 years. It is no surprise then why many prefer PEX over copper. Given the higher labour, material, and maintenance costs associated with copper, it is simply impractical not to go with PEX instead. This shows how vital it is for your appraiser to have insight on current standards of material and design in order to produce the most accurate Total Insurable Value (TIV) for your property.

 

Qualified appraisers will have the specialized skills and training to determine appropriate costing estimates that take into consideration additional factors such as functional obsolescence, current building practices, and technology improvements. For your peace of mind, leave insurance appraising up to the experts. At Normac, our appraisers keep up to date with construction methods, trends, costs, building codes, bylaw, demolition costs, and provincial Condominium and Property Acts to ensure you are paying for exactly what you need. No more, and no less.

COVID-19 and the Canadian Condo Market

Need More Space

Amidst the COVID-19 pandemic, even the experts could not have predicted the strength of the Canadian real estate market – of which includes record high prices and fierce bidding wars – all in the face of double-digit unemployment across the country. “Our views are changing,” says Robert Hogue, a senior economist with Royal Bank of Canada. “The strength in the summer was quite a bit stronger than we might have thought. Clearly, there was pent-up demand from March and April, but we didn’t think it would pop that much.”

Condo Market Trends Covid
Source: https://wowa.ca/reports/canada-housing-market

WHY ARE PRICES INCREASING?

Of course, a major factor in the overall increase in home sales reflects the record-low mortgage rates we are seeing currently. The prime rate this year has gone down to 2.45%, a sharp decline from 3.95% from last year.  Canadians have been able to purchase more expensive homes with the same monthly payments as in the past. Government support programs such as CERB and CEWS have also supported household incomes.

Source: https://wowa.ca/reports/canada-housing-market

DETACHED HOMES MORE DESIREABLE

In keeping with supply and demand, the single detached or low-rise market may continue to see price increases, however the big-city condo segment is expected to be most vulnerable to post-COVID volatility. As we see a shift from physical offices to virtual/home offices – the demand for larger spaces have increased. Additional factors such as declining immigration and a softer rental market have also played a role in this trend. In June, this year there were 19,000 permanent residencies granted, a decline from 34,000 from the same time last year.

In the beginning of 2020, we witnessed condo prices outpacing that of detached homes. The first quarter of 2020 showed new condo prices in the Greater Toronto Area (GTA) up 14.6% from last year, and resale prices up 8.5%, according to data from Statistics Canada. In Ottawa, the increase was 22.6% for new condos and 15% for resales. Vancouver however, had experienced slight decreases year-over-year. According to the Real Estate Board of Greater Vancouver, apartment home sales had increased year-over-year in August (1,332 versus 1,095), however the shift to detached homes were up 55.1% in comparison to apartments – a modest 19.4%.

THE TOLL ON THE CONDO + RENTAL MARKET

Although we are seeing overall increases in pricing and sales activity, the condo market segment has been trailing behind other home-types since March. “We were seeing stronger sales on the single-detached front,” says Jason Mercer, chief market analyst for the Toronto Regional Real Estate Board (TRREB), “and we’re also seeing more listings coming on for condo apartments, so that’s moving toward a more balanced market.” The shift to suburban locations and preference for more space has also taken a toll on the condo rental market. Rent prices have been declining due to higher vacancy rates and renters are seeing more favourable rent conditions.

 

The Canadian Mortgage and Housing Corporation (CMHC) has purchased $5.8 billion of insured mortgage pools this year in preparation for COVID-19 related mortgage claims. As of July 1, the CMHC has introduced stricter underwriting criteria – which includes more rigorous credit checks and tighter down payment requirements for insured mortgages. It is safe to say, that for the time being the condo market will continue to see short term uncertainty until a COVID-19 vaccine has been introduced with proven results. The long-term effects of this emerging trend are yet to be determined.

If you are buying into the Canadian condo market, it is imperative that you adequately insure your asset. In fact, most provincial condominium bylaws mandate that all condominiums are insured to their total replacement cost value. 

The only way to determine accurate replacement cost is by obtaining an insurance appraisal by a professional 3rd part firm, like Normac. Doing so means you will always be sufficiently insured in the case of a total loss, that you can receive better terms and insurance rates, and that you fulfill your fiduciary duty set by your provincial condominium bylaws.