Depreciation

Depreciation is so important to the appraisal of real property. In its real sense it means a loss in value from any cause. A simple example is an automobile. Each year it depreciates and is worth less money. The reasons are (1) age and (2) wear. Depreciation in the real sense of the word is sometimes hard to relate to real estate. It is quite common to find aging buildings that are selling for higher prices than in years past. In­stead of depreciating in value, real property over the years has tended to appreciate in value.

In addition to depreciation in the sense of a loss in value, another common type of depreciation that affects property is depre­ciation for tax purposes. It is actually a method of returning to the investor in busi­ness or income property, over a certain number of years, an amount equal to the purchase price of the building.

Before discussing depreciation for tax purposes, let us return to the traditional de­value from any source. This depreciation in­cludes all the influences that reduce the value of the property below its replacement cost new. The principal influences are phys­ical deterioration, functional obsolescence, and economic and social obsolescence.

Physical deterioration is wear and tear from use and from the elements. It may also result from negligent care, dam­age by termites, and damage from dry-rot or from wood-destroying organisms.

Functional obsolescence means poor architectural design and style - the lack of modern facilities and out-of-date equipment and poorly planned interiors and lack of ad­equate space.

Economic and social obsolescence means misplacement of improvement. An area that 50 years ago was completely resi­dential has changed over the years, so now it is a mixture of residential, commercial, and perhaps light manufacturing. What few residences remain is now economically and socially obsolete. They are wrong for the location as far as their use is concerned. Detrimental influence of supply and de­mand and zoning or legislative restrictions also cause this type of obsolescence.

While the first and second groups above are considered to be inherent in the prop­erty itself, the third group of influences con­sists of factors that are extraneous to the property itself. Physical and functional de­preciation may be corrected by modern­ization and improvement of the existing structure. New wiring may be installed, plumbing modernized, kitchens and bath­rooms brought up to date, and modern heating systems installed. Economic and so­cial obsolescence is much more difficult to correct and usually necessitates an urban renewal and redevelopment project on a large scale.