Depreciation is the loss in value of improvements through any cause whatever. "Accrued depreciation"
is the difference between the "replacement cost new" and the market value of the building. All buildings
no matter how well maintained will have a market value less than "replacement cost new" after completion.
For example, a building one year old will be worth less than an equivalent new building, if for no other
reason than technological change, and a shorter life expectancy. Depreciation can be classified as follows:
* PHYSICAL
* FUNCTIONAL
* ECONOMIC
PHYSICAL DEPRECIATION
"Physical depreciation" is tangible depreciation that can be seen upon inspection of the building.
For example, the need for paint and repair. It is caused by aging, structural wear and tear, deterioration,
and disintegration and is increased by poor maintenance and/or a badly designed building. It is either
"curable" or "incurable".
FUNCTIONAL DEPRECIATION OR OBSOLESCENCE
Functional depreciation or obsolescence of a building is the loss in value caused by poor, inefficient,
old fashioned or an unpopular design. The bad design results in an inefficient and costly building compared
to modern and well designed buildings. For example, if the developer builds a triangular building on a square
block of land, the triangular shape results in tenants not being able to fully utilize the inside corners and
therefore, wastes space. Similar arguments apply to round buildings. Further, the cost to build is more than a
rectangular building.
An old design now unpopular is "functional obsolescence". For example, the old bank buildings in Martin Place,
Sydney, built in the late 1800s and early 1900s have very high ceilings and thick stone walls. Such buildings
have a low net lettable floor area to gross floor area ratio, a great deal of wasted space (particularly vertical
space), are difficult and expensive to air condition and generally, to upgrade to the modern standards required
by tenants today. Demolition and rebuilding is the most economical solution for buildings of this type.
ECONOMIC DEPRECIATION
Economic depreciation or obsolescence is a loss in building value caused by external economic and legal
environments ("macro" valuation factors). The loss in value is intangible and cannot normally, be cured.
EXAMPLE
A change of zone that makes an existing building obsolete because it is no longer the "highest and best use"
of the site. For example, a residential cottage on land that has been recently zoned for industrial purposes.
The intending purchaser will pay nothing for the building because it will have to be demolished when the new
factory is built. In fact, the building is a detriment to the site and the purchaser will pay less than for an
equivalent site without the cottage.
Economic obsolescence is also be caused by neighbourhood hazards and nuisances (eg a nearby nuclear installation),
changes in supply and demand, and a lack of flexibility in design (eg a factory built and designed to
manufacture one product which is now obsolete). If the land is not being put to its highest and best use then
the building is worth less than equivalent buildings designed for the higher and better use. If the uneconomical
building cannot be economically converted to the highest and best use it suffers 100% accrued depreciation
and has demolition value only.
See future depreciation
See cost method of valuation
See depreciation and income tax – commercial buildings
See depreciation questions