Depreciation is a fundamental concept in real estate appraisal, reflecting the decrease in property value over time due to various factors. It represents the difference between the value of a new property (as if newly built) and its current market value. Understanding and accurately estimating depreciation is crucial for real estate valuation for sale, purchase, financing, insurance, taxation, and investment decisions.
Depreciation estimation is based on scientific, engineering, and economic foundations. It requires an in-depth understanding of the physical factors affecting the property's condition, such as wear and tear from use and weather conditions. It also requires understanding functional factors that make the property outdated or ineffective compared to modern alternatives, as well as external economic factors that affect the property's attractiveness in the market. Accurate depreciation estimation ensures a fair and objective property valuation, contributing to the efficiency and transparency of the real estate market.
This chapter will review the concept of depreciation and its various types, focusing on the underlying causes and effects on property value. Three main types of depreciation will be covered: Physical Deterioration (resulting from the natural wear and tear of the property's physical components), Functional Obsolescence (resulting from deficiencies in the property's design or its unsuitability for current needs), and Economic Obsolescence (resulting from external factors that negatively affect the property's value, such as changes in the market or the surrounding environment).
The different methods for estimating depreciation, which include the Economic Age-Life Method, Sales Comparison Method, Capitalization Method, Cost to Cure Method, and Observed Condition Method, will be discussed in detail. Each of these methods will be explained in detail with illustrative examples.
