Depreciation

April 2011

Depreciation means different things in different contexts.  Most people first think of accounting depreciation.  Depreciation in appraisal or assessment context is different.  This depreciation, simply put, is the difference between the current cost to replace a structure and the current contributory value of the structure.  If it would cost $200,000 to replace a dwelling but the dwelling only contributes $150,000 to the total market value of the property, then the depreciation is $50,000 or 25%. 
 
This 25% loss in value can be caused by any of three causes.  The most typical cause is wear & tear, the structure ages.  The roof may be near the end of its life.  The dwelling may need painting.  This type of depreciation is not caused by an accounting function.  It is a result of buyers not being willing to pay as much for a dwelling with known wear and tear as they would pay for a brand new dwelling.  The amount of this type of depreciation is not strictly based on the age of the structure.  There are many examples of 100+ year old dwellings that have been completely remodeled and that have sold for almost as much as a brand new dwelling. 
 
The second type of depreciation is a result of some functional problem with the structure. The room design may be a problem.  In some older dwellings you may have to go through one bed room to get to another.  The problem may be with the design of the dwelling.  A dwelling designed for the southwest may suffer functional depreciation in Vermont.  This type of depreciation is similar to the first type because it is a result of buyers not being willing to pay as much for a dwelling with functional problems as they would pay for a dwelling without the problems.  A dwelling may be brand new or remodeled with no wear and tear, but its value is diminished because of functional problems.
 
The third type of depreciation is caused by influences external to the property.  A residential property next to a busy airport may not sell for the same value as the same property in a quiet neighborhood.  Given the choice, buyers would prefer to not live next to a busy airport.  Sellers of dwellings next to a busy airport will have to reduce the price to induce buyers.  This reduction in value is the third type of depreciation. 
 
A property may suffer from all three types of depreciation.  Appraisal depreciation of all three types is a result of the actions of buyers and sellers, it is not an accounting function.