Appraisal & Depreciation
Posted October 2nd, 2017
An appraiser’s job is to take many things into account about a particular home, including outside influences like the type of neighborhood and similar recently sold homes. While some people debate the various external things that go into a valuation, depreciation is a practice that takes into account the actual condition of the house.
Depreciation is what most people understand as the decrease in value due to damage. For most homes, there will be normal wear and tear, and it usually isn’t enough to trigger a depreciation rate, however, larger issues such as foundation problems and natural disaster damage will. This particular group – damage and destruction – is called Physical depreciation. There are two other types of depreciation that deal with equally as important called functional and external obsolescence.
Functional obsolescence deals with a loss in value because of outdated functionality. An example would be homes with one or fewer bathrooms. While bedrooms still find functionality from studio to four or more, a house with not enough bathrooms poses as a problem on the market and therefore is considered “outdated.”
On the other hand, external obsolescence focuses apart from the home. External depreciation is viewed from economic factors that can be adverse to a home. For example, when the zoning around an old home or neighborhood changes and something undesirable will be built next to them, such as a landfill. In the event that these homes still remain (unlike being sold and torn down) their value would depreciate.
Determining Appraisal Depreciation
Like the particular depreciation types, there are three ways to achieve the actual depreciation rate. The most common is the age-life method which calculates the effective age of the home and dividing the “economic life” to come to a percentage of depreciation. If the home is 25 years old with an effective age of 20 and the remaining economic life is 70, then the reduction would be 29%.
The market-extraction method is much more complicated, and appraisers can spend months learning how to calculate it correctly. However, the simple explanation is that market method removes the land values of similarly sold homes and compares it to the property in question. This usually exposes a consistent depreciation rate among all of the properties.
The break-down method works a lot like it sounds. It breaks down individually depreciated items of a property and then adds them together and deducts the sum from an estimated reproduction or replacement cost in the event of damage and repair. This method is the least common because of its complexity and how time-consuming it can be but does have its place in appraising if the right circumstance applies.