Opportunity from obsolescence

REDEVELOPMENT: External factors such as economic and environmental obsolescence drive the redevelopment of buildings, writes Chris Yong

Worldwide, there is a constant recycling of buildings with new buildings replacing old ones, as such the skyline in the city and suburban centre keeps changing. This process is driven partly by economic obsolescence and partly by scarcity of resources. When we talk about obsolescence, we are talking about the reduction in value of property due to external factors in the neighbourhood. The causes include changes in regulatory rules, zoning, market changes, construction of say, nuclear waste site etc.

In respect of building components, the value decreases over time due to wear and tear and depreciation. Land is another story, its value goes up or down depending on its location.

In accounting/valuation terms, theoretically, a building has a ‘lifespan’ of 60 years, which means it depreciates to zero value when it reaches the end of its timeline. Of course, we can extend its ‘life’ by refurbishing or renovation. In many prime locations, the economic benefit occurs when the reduction on building value is offset by the appreciation of the land which in turn gives rise to redevelopment potential.

In many ways, redevelopment occurs because of market forces, it makes financial sense to unlock the value in certain locations because the land value has gone up a lot. For example, if you have a bungalow in Jalan Ampang surrounded by high-rise high end buildings, it makes sense to enhance and carry out value-added improvements.

When the building-to-land value ratio is miniscule, it has financial implications in terms of usage. It means the opportunity cost is great if you do not develop it. It’s better off demolishing the old building and applying for planning permission to start a project with greater gross development value (GDV).

Anyway, prices can move things. Price mechanism is a powerful operational tool, it also affects resource allocation. It ensures that limited resources are allocated to those who have the most productive uses for them, thus minimising waste and inefficiency.

Functional obsolescence: Another consideration is functional obsolescence. When properties are built, sometimes they don’t always adhere to a given standard floor plan and site design. When this happens, depreciation is caused by loss of building utility; in other words, if a building has reduced usefulness due to poor design, the appraised value must also be reduced.

For example, buildings that are too big within an area which is considered an over-improvement or a property that is relatively small compared with those around it which is considered an under-improvement. If a building is said to be out of place or poorly designed for its location, it is considered as ‘functionally obsolete’.

Other than this, market changes also affect functionality. For example, more than 10 years ago, flatted (multilevel) factories were common but the market acceptance for this product did not take off. It lost its popularity because of logistic problems associated with moving goods up to higher levels to store them. Today most of the flatted factories in Petaling Jaya have been converted to office use.

Recently, we see redevelopment happening in section 13, a mostly industrial area in Petaling Jaya. This is driven partly by zoning regulations whereby there is a local plan specifying commercial use. Due to rising land value as well, there is impetus for them to relocate to cheaper industrial areas and since the current returns are not maximised, there is also incentive to opt for ‘next best use’.

Niche brownfields: Competition to get ‘greenfields’ to develop in city centres is heating up among developers due to the scarcity of land. That’s why developers are scouting for ‘brownfield’ land in the secondary market. They are looking beyond buildings; their aim is to tear down the old buildings to get the ‘land’. There are certain asset fund managers who look for this type of niche market, their objective is to enhance the value of the project upon redevelopment. They know what to keep and what to demolish for redevelopment.

For example, the asset fund managers who bought an integrated development near Jalan Ampang/Jalan Tun Razak junction, proceeded to refurbish the hotel component but tore down the office tower and shopping mall. When you tear down the office tower and shopping mall, you actually destroyed the portion of value attributed to the buildings. In order to recoup back the ‘loss value’, they have to increase its overall total development value. They managed to do that by applying for higher plot ratio, thereby increasing its total built-up space. They rebuilt two new office towers and a bigger new mall at the same location.

Lastly, there is another type of obsolescence called environment obsolescence. This decreases both the value of the building and land, for example, houses near a nuclear waste site, garbage dump, airport construction etc.

In summary, property redevelopment is driven by economic forces and government policies where economic obsolescence plays a vital part.
 

Chris Yong is principal of Rochester Properties.

 

We can extend ‘life’ of buildings by refurbishing or renovation.

1 / 2