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Depreciation / Appreciation

Discussion in 'Real Estate' started by -T-, 8th Apr, 2006.

  1. -T-

    -T- Well-Known Member

    2nd Apr, 2006
    Just food for thought...

    You know how everyone laments the fact that land appreciates and buildings depreciate, well have you ever thought in more depth about that? Sure for accounting purposes buildings and improvements depreciate, but what about looking at the real value.

    For example:
    Purchase house in 2001
    UCV = $100k
    Price = $170k

    Sell same house in 2006
    UCV = $280k
    Price = $440k

    There are only so many things one can conclude from this:
    • UCV is not a real representation of land value
    • There is a premium that is not land or improvement-based
    • The data is inaccurate or an exception to the rule
    • The improvements have actually appreciated

    For the first point (UCV), you can simply look at the price of real land parcels during the sample periods. I have looked and they aren't much different.

    For the second point, maybe there is a premium for buying at the top of the market. But then that would suggest when it flattens that land would remain the same and houses would drop. Hmmm, that sounds too odd though.

    For the third point, I've checked, it is the norm in my area.

    For the last point, this could be possible if building costs have increased. I realise the sample house was already built, but rising construction costs would add value to existing structures wouldn't they?

    Anyway, this has always bugged me but I didn't know why. I think the same goes for apartments, I don't believe it is just the land value that increases. All you have to do is run a simple test on existing properties to see what I'm talking about.

    However, I could be totally wrong and have missed something and you guys are going to have to teach me a lesson I'll never forget. :D

  2. jscott

    jscott Well-Known Member

    10th Jan, 2006
    the cost to replace the house will be going up each year so this might have something to do with it.
  3. Rickson

    Rickson Well-Known Member

    23rd Oct, 2005
    Also, the value of renovation is almost as much as the value of new construction. And these figures might not count the cost of minor upgrades such as replacing floor coverings.

    This stat makes me worry that the reported performance of residential real estate is overstated, because it does not subtract the value of the continual upgrading of property.

    But I do know that property investment has worked for us - the power of leverage.
  4. Jacque

    Jacque Team InvestEd

    16th Jun, 2005
    Interesting discussion, T :)
    And a topic that lends itself to interpretation as well. Almost all of us could pinpoint a property or two that defies the popular RE adage that "Land appreciates. Buildings depreciate". After all, it's a widely used generalisation amongst property investors. There are always going to be properties that go against the golden 'rules', however, so we need to acknowledge that first.

    Secondly, looking at the example you've provided, I notice that the land value is appreciating over time. In 2001 the land content made up just over 58% of the total value, whilst in 2006 it was closer to 63%. Not much, I know, but it's still rising. As you also note, UCV's aren't always necessarily correct either (just ask the OSR- I have no doubt they've fudged some figures lately when issuing those land tax bills!!! ;) ) and this can result in incorrect assumptions about value.

    You're also correct when you suggest that rising construction costs should add value to exisiting structures. One has to take into account the replacement cost of buildings which generally rises over time as well. However, without maintenance, buildings can fall into disrepair and become only worth a fraction of their original cost or, at worst, worth nothing. When it gets to the point where the land value has caught up to a large portion of the value (85%+) then I would consider it a "knockdown" job.

    Don't forget, too, that during the first years of a building's life, depreciation may be slower as everything is still newish and owners (in particular) tend to go and add value adding items such as decks, fittings like BIR's, appliances and landscaping. Within a few more yrs, though, depreciation usually escalates and, if the location is good, the land value increases. Naturally, location matters most as well as supply and demand and, as new buyers move in, older places get knocked down or extensively revamped and the cycle begins all over again.

    I welcome contributions here from other members on this topic. Great discussion material :)
  5. -T-

    -T- Well-Known Member

    2nd Apr, 2006
    Thanks for the replies All!

    Don't get me wrong, I realise land will appreciate much more than any building, but I think it's interesting that it isn't as simple as presented in books and seminars. On paper, buildings depreciate. But even the fact that they may appreciate due to factors such as rising building costs, makes me think twice.

    However, Rickson brought up a good point that I completely overlooked; renovations. :eek:

    Jacque: good points about the diminshing ratio of building to land value. I guess because I haven't been around long enough, I seem to forget that a newish house can become a knock-down while I still own it.

    I looked at the median price in Canberra, for example, in 1980; 44,675. How much of that do you think is land and building? Even if land = 15k and building = 30k, that same house now is probably worth 100k+. We went to an auction the other day for a house about 25 yrs old (it looked very 'original'; maybe a few new coats of paint, but not much else) and it went for 445k. The UCV was about 280k. This would have been an average house in 1980. Using simple maths, that house has gone from maybe 30k to more than 150k.

    I realise when a house is no longer standing, it is worth less than $0 (clean up costs). But I think it's worth the thought that an average building could appreciate 500% in 25 years. Even converting 30k in 1980 to today's value with 3% inflation, you only get about 64k. But with land values people don't consider inflation properly anyway. I guess what I'm getting at is that it is simply wrong to make the sweeping statement that land appreciates while buildings depreciate. Sure buildings will eventually depreciate, but so will land with a certain length outlook. (I'm talking another ice age here) :)

    Feel free to pull my logic to pieces :D
  6. Nigel Ward

    Nigel Ward Team InvestEd

    10th Jun, 2005
    Mr T :D

    As long as you understand the concept of buying properties with a high land content...does it matter?

  7. -T-

    -T- Well-Known Member

    2nd Apr, 2006
    Hi Nigel

    You're 100% right, it doesn't matter to my strategy at all.

    When I first started reading and learning about investments, I took most of what authors said as gospel. I'm learning to take everything at face value now because things just don't add up. This isn't the first concept that I've proven wrong with real data. Other than the concepts of leverage and compounding, I've almost proven everything in one particular book as false. Now I have trouble reading books that start by quoting the same concepts. I know, I'm dealing with the really important issues, but hey... it's important to me. :D