In real estate appraisal, depreciation is a loss in value from any cause — not merely wear and tear, and not the accounting concept of depreciation used for tax purposes. Appraisers use it specifically in the cost approach to estimate the difference between what a building would cost to build new today (replacement cost) and what the existing building is actually worth given its current condition, design, and location.
Accrued depreciation = Replacement Cost New − Depreciated Value of Improvements
The land is never depreciated — land is assumed to hold its value indefinitely. Only the improvements (structures) depreciate.
There are three types of depreciation, organized by cause:
1. Physical deterioration — caused by wear, age, and deferred maintenance 2. Functional obsolescence — caused by poor design, outdated features, or over-improvement 3. Economic (external) obsolescence — caused by forces outside the property
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Physical deterioration is the most intuitive form of depreciation — the literal wearing out of a building and its components. It results from:
Physical deterioration is classified as either curable or incurable:
Curable means it is economically feasible to repair — the cost to fix the item is less than (or equal to) the value the repair adds. The item needs fixing, and fixing it makes financial sense.
Examples:
California context: In a Bay Area renovation, replacing original 1970s fixtures with modern equivalents is typically curable — the cost of the work is less than the market value added.
Incurable means the cost to repair the item exceeds the value the repair would add, or the item is structurally embedded and cannot practically be repaired. The owner would lose money fixing it.
Examples:
California context: Many older California buildings, especially unreinforced masonry structures in earthquake zones, have incurable physical deterioration — the cost to bring them to modern seismic standards exceeds the value increment.
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Functional obsolescence is a loss in value caused by features of the property itself that are no longer considered desirable by the market — whether because the feature is outdated, poorly designed, or the wrong size for the market.
Functional obsolescence can arise from:
Functional obsolescence is also classified as curable or incurable:
Can be fixed for less than the value it adds to the property.
Examples:
Cannot be economically fixed — either physically impossible or costs more than the value added.
Examples:
California example: A 1960s tract home in the San Fernando Valley with only 1 bathroom and 3 bedrooms suffers functional obsolescence — the market expects at least 2 bathrooms. Adding a bathroom may be curable; having an awkward layout that cannot be practically reconfigured is incurable.
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Economic obsolescence (also called external obsolescence) is a loss in value caused by forces outside the property — factors in the surrounding neighborhood, local economy, or broader environment that negatively affect the property's value.
Economic obsolescence is always incurable — the property owner cannot fix external factors.
Examples:
California examples:
Because external obsolescence is caused by forces the owner cannot control, it is always treated as incurable — the owner cannot fix a freeway or a declining economy.
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In the cost approach, appraisers calculate an annual depreciation amount using the straight-line method:
Annual Depreciation Rate = 1 ÷ Economic Life
Annual Depreciation Amount = Cost New × Annual Rate
Total Accrued Depreciation = Annual Amount × Effective Age
Chronological age is how old the building actually is (calendar years since construction). Effective age is how old the building appears to be based on its condition and maintenance — it may be younger or older than the chronological age.
A well-maintained 30-year-old home may have an effective age of only 15 years. A neglected 15-year-old home may have an effective age of 25 years. Appraisers use effective age in depreciation calculations, not chronological age.
Example: A building has a replacement cost new of $800,000, an economic life of 50 years, and an effective age of 10 years.
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| Type | Cause | Curable? | |---|---|---| | Physical deterioration — curable | Wear; repair cost < value added | Yes | | Physical deterioration — incurable | Structural wear; repair cost > value added | No | | Functional obsolescence — curable | Outdated feature; fix cost < value added | Yes | | Functional obsolescence — incurable | Poor design; physically/economically impossible to fix | No | | Economic/external obsolescence | External forces (noise, economy, environment) | Never |
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Quiz Questions:
Q1. An appraiser is valuing a 1960s home in Burbank. The carpet is badly worn and needs replacement — the cost to replace it is $8,000 and the replacement adds $10,000 to market value. The roof structure has severe wood rot throughout requiring full replacement at a cost of $85,000, which would add $60,000 to the home's value. How should the appraiser classify these items?
A) Both are curable physical deterioration B) The carpet is curable physical deterioration; the roof rot is incurable physical deterioration C) Both are incurable physical deterioration because the home is over 60 years old D) The carpet is functional obsolescence; the roof rot is economic obsolescence
Answer: B — Curable means the cost to fix is less than the value added: carpet ($8,000 cost vs. $10,000 value added = curable). Incurable means the cost exceeds the value added: roof rot ($85,000 cost vs. $60,000 value added = incurable). Both items are physical deterioration — they result from wear and physical damage.
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Q2. A 4-bedroom home in Santa Ana has only one bathroom. The market strongly demands at least 2.5 bathrooms for a home this size. Adding a second bathroom would cost $25,000 and add $40,000 to market value. How should an appraiser treat this?
A) Incurable functional obsolescence — the market simply doesn't want single-bath homes B) Curable functional obsolescence — the cost ($25,000) is less than the value added ($40,000), making it economically feasible to fix C) Incurable physical deterioration — single bathrooms are a structural deficiency D) Economic obsolescence — the neighborhood norm is causing the value loss
Answer: B — A single bathroom for a 4-bedroom home is a deficiency — a form of functional obsolescence. Because adding a bathroom costs $25,000 but adds $40,000 in value, it is economically feasible to cure. This is curable functional obsolescence.
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Q3. A single-family home in Inglewood was recently affected by expanded LAX flight path changes, adding significant aircraft noise over the neighborhood. This is best classified as what type of depreciation?
A) Curable physical deterioration — the homeowner can install soundproofing B) Incurable functional obsolescence — the floor plan cannot accommodate the noise C) Economic/external obsolescence — the loss is caused by an external force the owner cannot control, and it is always incurable D) Curable functional obsolescence — noise can be addressed by retrofitting the windows
Answer: C — Aircraft noise from a flight path is an external force entirely outside the property owner's control. This is economic (external) obsolescence — always incurable by definition, because the cause is outside the property. The homeowner can add soundproofing, but that addresses symptoms, not the cause; the appraiser still recognizes the external obsolescence.
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Q4. A commercial building has a replacement cost new of $1,200,000, an economic life of 40 years, and an effective age of 8 years. The land is worth $300,000. Using straight-line depreciation, what is the estimated total property value under the cost approach?
A) $1,260,000 B) $1,260,000 C) $1,260,000 D) $1,260,000
Answer: Annual depreciation = $1,200,000 ÷ 40 = $30,000/year. Accrued depreciation = $30,000 × 8 = $240,000. Depreciated value of improvements = $1,200,000 − $240,000 = $960,000. Total value = $960,000 + $300,000 land = $1,260,000.
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Q5. An appraiser notes that a home's chronological age is 25 years, but it has been meticulously maintained, updated, and renovated throughout. The appraiser assigns an effective age of 10 years. How does this affect the depreciation calculation compared to using chronological age?
A) Using effective age of 10 years results in less accrued depreciation than using chronological age of 25 years, producing a higher depreciated improvement value B) Using effective age of 10 years results in more accrued depreciation, reducing the property's value C) Effective age and chronological age always produce the same depreciation amount D) Effective age is only used for functional obsolescence, not physical deterioration
Answer: A — Effective age (10 years) is less than chronological age (25 years), meaning the building has depreciated less than its calendar age would suggest. Using a younger effective age results in less accrued depreciation, which produces a higher depreciated improvement value and a higher total value estimate — accurately reflecting the well-maintained condition.