Except for some industrial property types such as manufacturing, it usually pays to develop to reasonably current design standards; changing social needs have also altered the viability of some designs.
For example, many U.S. cities still sport those cantilevered federal buildings with multiple exterior stairs that now defy easy access due to increased security measures. Just try to use those stairs!
In perhaps the best example, enclosed malls across the country lucky enough to still have anchor tenants are desperately trying to renegotiate lease terms for those anchors. Not only do these older enclosed malls have outdated designs, functionally obsolete elements, inefficient layouts, and below standard (expensive to correct) components, but the photo above shows a different kind of awkward… an uncomfortable, uneasy, and problematic situation that is the reality in too many towns.
The examples above, along with others, reflect a type of obsolescence that is easy to spot, yet difficult to model accurately. But increased risk can be considered. The valuation metrics in these cases are readily apparent and adjustable:
- Lower rent
- Increased market vacancy
- Possible design-based expense increase
- Increased discount rate and overall capitalization rate
As usual, the amount of enhancement to the overall capitalization rate is the challenge. Consider comparing the difference between first tier investment grade cap rates and third tier non-investment grade cap rates as a floor for this adjustment. If you find the differences hovering consistently near a certain percentage, keep in mind that the rates (and therefore the differences) vary by property type, so carefully check your analysis.