How does depreciation affect the cost approach to valuation?

Depreciation plays a crucial role in the cost approach to valuation by helping to adjust the cost of a property to reflect its current value. When appraisers use the cost approach, they start with the replacement cost of the property—how much it would cost to construct it today, using current materials and labor costs. However, properties naturally lose value over time due to factors such as physical wear and tear, functional obsolescence, and economic obsolescence.

Accounting for depreciation allows appraisers to subtract the lost value from the replacement cost, yielding a more accurate representation of what the property is worth in its current condition. By adjusting for depreciation, appraisers can provide a realistic market value that encompasses both the initial investment and the property’s present state.

Understanding depreciation is key for assessing both older and new properties, as even newly built structures can experience functional or economic obsolescence shortly after completion. This adjustment is essential for systematically determining a property’s market value based on its actual condition rather than just its cost to replace.