Everything you need to know about depreciation of property

[ecis2016.org] When selling a property, one must account for the remaining number of useful years of the property or building. Learn more about property depreciation in this article

Everything of value depreciates over time. If you are planning to sell old gold, for example, there is a certain depreciation that the purchaser factors in. This is usually a small percentage. In real estate too, the age of the building determines its depreciation. In this article, you will understand how to calculate the depreciation of a property.

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What is depreciation of property?

Before we start discussing the topic, do remember the following two important points.

1. While the building depreciates with time, the land value keeps appreciating.
2. Location plays an important role in determining appreciation or depreciation value.

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The age of the property or age of construction, is a key factor in deciding the depreciation of a property. You may need to factor it in, especially if you are a seller and are trying to estimate the right price for the property. As already mentioned, the value of land on which the property is built upon does not depreciate. Over time, it only appreciates.

A question that often arises, is why are resale apartment properties usually sold at a higher price? This is because, when you buy an apartment property, you are also buying the Floor Space Index (FSI) of the land upon which the property is built and the cost of land is appreciating. Land is valued at market prices even in the case of an independent house and it is the structure that decreases in value.

An old construction is not as attractive as a new one and therefore, its value dips. However, there are exceptions too, which we will discuss later in this article.

How to calculate depreciation of property

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The useful age of an independent house is 60 years. Now suppose that a couple, Radhakrishnan and Mohini Iyer, decide to sell this property after 20 years of construction, what should the selling price be?

In such cases, depreciation is arrived at through the following formula:

Number of years after construction / Total useful age of the building = 20/60 = 1/3

This is the remaining useful age.

The Iyers should consider a 1/3rd deduction in the price of the building.

So, building price = Market price x (1/3)

To this building price, the Iyers will also need to add the price of land, that is, the market value of land, to arrive at the total price of the property.

Exceptions: Factors that impact calculation of depreciation

The above-mentioned formula may not work in certain cases.

When land is scarce

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In the absence of a land bank, existing land remains in high demand. On top of it, if the locality is very popular, a seller can command a premium and the concept of depreciation may be inconsequential. A prospective home buyer, in such cases, may be more interested in owning a house in a prominent and preferred locality.

Emotional connect with a certain property or location

At times, a property in a certain location or the locality in itself may have additional value. Let us consider an example. 35-year-old Satwik Das was born and brought up in Kolkata. At a very young age, he lost his parents and was taken care of by his relatives. When he had the money, he chose to buy the same property in Ballygunge where he grew up, because of the emotional attachment. In such cases, where the buyer may not be constrained due to his budget, he may not mind paying a little extra.

Obsolescence factor 

When new products enter the market, old ones usually go out of fashion. This is called the obsolescence factor. For example, outdated utility or building design faults. In such cases, the seller may have to reduce the price, because calculating the depreciation of the building alone does not compensate the prospective buyer for the drop in the building’s value.

Depreciation of property: What should sellers know?

If you are looking to sell your property, be sure to consider the price after calculating the depreciation. In certain cases, you may command a premium owing to the demand. This is in no way wrong. However, if you see that the property is on the market for a long time, with almost no inquiries coming your way, it may be time to approach a valuer who can estimate the right price for the property.

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While many buyers may be willing to spare a few extra lakhs, you may find it very tough to find a suitable buyer if the property is excessively priced.

Also note that if your property is old and requires renovation, this may cost the buyer an additional 5%-8% of the property’s cost. A prospective buyer who comes for a site visit will necessarily take these into account, to determine whether or not to buy the property.

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