Depreciation Overview

Depreciation is a decrease in value or worth. It may be defined as a loss in value of an old building in comparison with a new building of similar construction. Deterioration, lack of utility, obsolescence, inadequacy, or other factors that reduce the usefulness of the building may cause loss.

Accrued depreciation considers the observed condition of the building in comparison with new units of similar construction, with consideration of physical deterioration and relevant functional factors. For insurance coverages, the replacement cost less depreciation is known as actual cash value.

Depreciation is divided into three categories: physical deterioration, functional obsolescence, and economic obsolescence.

Physical Deterioration

A loss in the value of a building caused by wear and tear from use, structural defects, and exposure to the elements. Within the control of an owner it is curable by maintenance, repair, or replacement. The measure of the amount of accrued depreciation is an estimate of costs to cure, limited by the amount that a prudent owner would be justified in spending. Deterioration may also be incurable due to an actual loss in the strength and remaining life of the basic components of the structure, which the owner cannot justifiably repair.

The amount of deterioration accrued to individual building components can be estimated by actual observation of their physical condition. A percentage is assigned for accrued physical depreciation according to actual observation of conditions.

Functional Obsolescence

A loss in value due to the development of new technology and is caused by factors inherent in the property. Inadequacy, lack of functional utility, and use of obsolete materials contribute to functional obsolescence.

It is necessary to consider functional obsolescence caused by overall layout, appearance, or design, which can make the building less desirable. Estimates of such depreciation depend upon the experience and judgment of the individual making the valuation. Unfortunately, there are no guidelines or tables to assist the valuator in estimating the depreciation from functional obsolescence.

Economic Obsolescence

A loss in value caused by unfavorable economic influences occurring outside the property, such as changes in zoning ordinances or environmental changes in the neighborhood.

Adjustments for economic obsolescence are made after all other forms of depreciation have been taken into account since it affects total property. No tables or guidelines exist for estimating this depreciation. The estimator must employ skill and observation, tempered by common sense.