What’s the difference between a newly constructed home and a hundred-year-old home? Depreciation! When developing an opinion of the market value of a property, what appraisers are really measuring is how much depreciation a property has suffered from, and more specifically how much depreciation the improvements on the land have depreciated.
When measuring depreciation using the age-life method, which residential appraisers often use, the first step is to develop an opinion of the value of the land. Why? Because we measure the depreciation of the improvements that exist upon the land. Not the land itself. Why?
While it’s true that land values change over time, the land is a finite thing. As Mark Twain once said, “Buy land, they’re not making it anymore.”
So, as populations continue to grow on earth, the land becomes more limited. Due to the scarcity of land, that is its limited supply, land values typically increase more than they decrease. When developing an opinion of the value of the land, any price fluctuation will be seen by using the most recent data available. Ideally, land sales are used. However, there are other methods for estimating land value. Land may sell for more depending on location, demand, and usefulness.
Land by nature is different than the improvements upon it. For instance, improvements upon land usually have a life expectancy of around 60 or 70 years. So, depreciation can be measured based on a specific life span. However, land has no life expectancy for which to measure depreciation. It continues to exist forever. The fluctuation of land prices is therefore not constant, making it nearly impossible to measure depreciation on a long-term basis.
Let’s think about the lot a house sits on. Let’s now jump into a time machine and go back a million years. The land is there, but its use is much different. Let’s say its use is a dinosaur park back then.
Here is the same lot (use your imagination) today. What about a million years into the future?
What about a million years into the future? Perhaps it will look something like this. Not too shabby!
The land has an unlimited physical life. Therefore, while uses may change, typically, the land can still be useful long after improvements that once existed on it are gone.
In measuring the depreciation of a home or other improvements, once the value of the land is determined, it can be deducted from the equation. Then the replacement cost of the improvement(s) is figured out. After which the market value of the improvement(s) is determined using different approaches to value. The difference between what buyers are likely to pay for those improvements and the cost to replace them, less the land, is the depreciated cost of the improvements.
One of the key factors needed to make this measurement is the estimated remaining economic life of the improvements. In other words, how long will the improvements contribute value to the land? This is an important question to answer when appraising a property. Why is this important to determine?
I just appraised a property in which the existing home no longer contributed to the land economically speaking. Therefore, the highest and best use of the house was to tear it down and sell the lot as a site upon which a new home could be built. Of course, if that happens, the land will still be there and will continue to function as it has in the past. The value of the land may change, but the land will still be useful. This is a good example of how an improvement’s contribution to the land does have an endpoint because the usefulness of the improvements has an endpoint. But the land continues to exist and have a use, which is why we don’t depreciate the land when measuring the depreciation of a home or other improvements.
From this information, you can see why developing a supportable opinion of the value of the land is an important step in measuring the depreciation of the home and any other improvements to the land. And hopefully, you now know why appraisers don’t depreciate the land in the process of measuring the depreciation of the improvements. Books have been written on the subject. I’m just lightly touching on a few things in the post.
If you’re not an appraiser, you might not care too much about this topic. However, I wanted to share it because I think most people think that appraisers just pick three comparable sales, put them in a report, and presto, we have a value. There is so much more that goes into an appraisal.
Hopefully, you found this article to be interesting. Thanks for being here!
Since we’re on a dinosaur kick, and since the Jurassic World Dominion movie is now in theaters, enjoy this little video with the trailers of the Jurassic Park movies from 1993 until today. It’s dino-mite!
If you’re an appraiser and you are looking to sharpen your skills in analyzing the market, check out George Dell’s Stats, Graphs, and Data Science 1 which will be starting next week! Click below to sign up or learn more.
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Here are some links to other articles I’ve enjoyed recently! I hope you will also…
The Housing Market Is Spiraling Downward With Dogged Determination – Housing Notes by Jonathan Miller
June Newsletter-Easing Off the Pedal – DW Slater Company Blog
Do I Need A Probate Appraisal? – Birmingham Appraisal Blog
Recession-Proof Your Money Part 1 – It’s a Good Life Podcast with Brian Buffini
Recession-Proof Your Money Part 2 – It’s a Good Life Podcast with Brian Buffini
Buyers gaining power & farewell real estate honeymoon – Sacramento Appraisal Blog
USPAP and the Contract – Tim Andersen, The Appraiser’s Advocate Podcast
Top Reason For House Rules – The Folson Group Blog
Too many appraisers? – APPRAISAL TODAY
No Judgement Needed? – George Dell’s Analog Blog
For my readers in the CLE area… here are some articles related to news in our local area. I hope you enjoy these also…
Laid off: enjoying summer pleasures while contemplating the future – Brittany Hooper of Fresh Water Cleveland
Superior Arts District’s new tenant brings jobs, art to in renovated warehouse – Marc Lefkowitz of Cleveland Fresh Water