New Jersey Real Estate Salesperson · Valuation and Market Analysis
Depreciation
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In 30 seconds
Depreciation is any loss in value of improvements from physical wear, outdated design, or forces outside the property, and it is the number subtracted in the cost approach. The most tested distinction is that physical and functional problems can be curable, while external obsolescence is always incurable because the owner cannot fix the neighborhood.
Why this matters
The exam hands you a worn roof, a one-bathroom house, or a new highway next door and asks which kind of depreciation it is and whether it can be cured.
The college version
In normal terms
- Physical deterioration is wear and tear; functional obsolescence is poor or outdated design; external obsolescence comes from outside the property lines.
- A defect is curable when fixing it costs no more than the value it adds, and incurable when the repair would cost more than it returns.
- The straight-line method spreads the cost of the improvements evenly over their economic life, so annual depreciation equals the cost of improvements divided by economic life.
Concepts in this outline
- Physical deterioration — loss in value from wear, tear, age, weather, and deferred maintenance on the structure and its components.
- Curable — a physical defect whose repair adds at least as much value as it costs, such as replacing a worn roof or repainting.
- Incurable — a physical defect, often in structural components, whose repair would cost more than the value it would return.
- Functional obsolescence — loss in value from an outdated or poor design, layout, or feature that the market no longer wants.
- Curable — a design flaw fixed economically, such as adding a missing bathroom or replacing outdated fixtures, where added value covers the cost.
- Incurable — a design flaw too costly to correct relative to the value gained, such as an awkward floor plan or low ceilings.
- External or economic obsolescence — loss in value from forces outside the property, such as nearby nuisances or economic decline; always incurable by the owner.
- Depreciation calculations and economic life — straight-line method: annual depreciation equals the cost of improvements divided by economic life; multiply by effective age for accrued depreciation.
Eli explains
The same idea, in plain words
Explain it like I’m 10
Land does not wear out, but buildings do. Depreciation in appraisal means the loss in value of the improvements, and it comes in three flavors.
Physical deterioration is plain wear and tear: a leaking roof or peeling paint. Functional obsolescence is a design problem: a four-bedroom house with one bathroom, or an old boiler that gulps fuel. External obsolescence, also called economic obsolescence, comes from outside the property: a highway roaring past the backyard or a closed factory.
Each physical or functional problem is either curable or incurable. The test is money: if fixing it adds at least as much value as it costs, it is curable; if the fix would cost more than it returns, it is incurable. External obsolescence is always incurable because the owner cannot move the highway.
To measure it simply, appraisers use the straight-line method over the building's economic life, the period during which the improvements add value to the land. Divide the cost of the improvements by the economic life to get annual depreciation, then multiply by effective age for the total so far.
Worked example
Noor inspects a Bergen County split-level for a cost approach. The worn front steps cost little to replace and fully recover their cost in value, so that is curable physical deterioration. The house has one bathroom for four bedrooms, and adding a second bath would raise the value more than the construction cost, so that is curable functional obsolescence. A commuter rail line now runs behind the yard, and nothing the owner can do will change it, so that is external obsolescence, always incurable. For the straight-line figure, the improvements would cost 400,000 dollars to build new and carry a fifty-year economic life, so annual depreciation is 8,000 dollars; at an effective age of ten years, accrued depreciation is 80,000 dollars.
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