What is Appreciation and Depreciation in Real Estate?
Regardless of the type of property you’re investing in, the property can appreciate or depreciate in value while you own it. Soon after the stock market crash in 2007, home values began to rise. Since that time, home values have consistently increased nationally with only small dips here and there, which means that investing in real estate tends to generate stable returns. While real estate typically appreciates and can help you build wealth for the future, there’s also a possibility that value will decrease, which is referred to as depreciation. The following offers a more detailed overview of appreciation and depreciation.
What Is Appreciation?
If you invest in an appreciating asset, you’ll be able to increase your wealth. Assets like real estate can appreciate for several reasons, which include higher demand among buyers, less supply, and changes in inflation. As a term, appreciation occurs when an asset’s value increase over an extended period of time.
Many investors are interested in real estate because of how common it is for properties to appreciate in value. This increase in value allows you to obtain a sizable profit if you eventually sell the property.
Which Factors Cause Appreciation?
There are a few factors that can lead to real estate appreciation, the primary of which is the surrounding housing market. The current housing market conditions can cause the property to appreciate. As mentioned previously, low supply and high demand typically lead to property prices increasing substantially.
The property’s location can also impact the appreciation rate. While national averages can give you a good idea of the potential for appreciation, local data from a specific real estate market is a much more accurate indicator of the possibility that property values increase. If you make renovations and improvements to your property, its value should increase.
What Is Depreciation?
As for depreciation, this occurs when an asset’s value decreases over an extended period of time. There are many reasons why depreciation occurs, which include everything from market fluctuations to notable issues with the foundation. Properly maintaining a home or apartment complex can keep depreciation at bay. Maintenance is necessary to ensure that the systems in the property retain their quality and don’t malfunction. Properties with older systems and appliances tend to sell for less.
Which Factors Cause Depreciation?
There are several reasons why an asset can lose its value over time. In real estate, damage to the property or appliances within the property can lead to buyers not showing interest when it comes time to place it on the market.
There’s also a possibility that market downturn will occur in your area if the local economy is poor. In this situation, it can be difficult to stave off depreciation. If structural problems or sewage problems are detected in a home, the value of this property would likely decrease until these issues are fixed.
Dealing with Rental Property Depreciation
If you’re looking to invest in a rental property but worry about depreciation, keep in mind that depreciation isn’t necessarily a bad thing in every situation. Real estate depreciation involves the structure itself worsening in value. However, the land that the structure is built on doesn’t depreciate.
If your rental property begins to depreciate, it’s possible to use a property’s depreciation as a deduction on your taxes. While you can subtract this depreciation for a single deduction when you first make the purchase, you could also divide the deduction by the property’s lifespan, which would allow you to deduct a certain amount from your taxes every year. The IRS states that a deduction can be made for 27.5 years when it comes to residential properties.
Even if your investment is appreciating after you buy it, it’s possible to improve your cash flow by lowering your taxable income with depreciation loss deductions. This type of deduction isn’t available with any other type of asset.
Appreciation and depreciation are common in real estate and will determine how successful your investment has been. Real estate investments have proven to be highly popular among investors because of how stable returns are. The majority of properties increase in value over time, which allows you to profit from appreciation. If depreciation occurs and your property value decreases, you should focus on identifying the cause of depreciation, which can help you determine if these issues could be fixed or if you need to cut your losses before they worsen.