Definition of commercial property investment depreciation
Depreciation is a well known concept in accounting but is also one of the major characteristics of direct commercial property investment.
Properties can depreciate even if their value is actually appreciating. Property investment depreciation is a relative concept and has been defined as the fall off in value of an existing property relative to a new property in the same location with a modern specification. Depreciation in both rental and capital values can be arrested by capital improvements and the ultimate cure for depreciation is to redevelop; although major refurbishment can sometimes also create assets that have similar values to new assets.
Different commercial properties have different characteristics and therefore different depreciation rates. Depreciation is ultimately tied to buildings which have a finite life, unlike the land element of any property investment. The standard high street shop unit in good locations within major cities or towns has a very high land content in its value. It is not uncommon to see buildings hundreds of years old standing next to modern buildings on the high street and given the uniformity of shop fronts it is hard to even notice the age gap. Annual depreciation and capital expenditure rates for high street shops are therefore very low. Offices on the other hand are less location sensitive, have a higher building content relative to land value and have a relatively short life, with high levels of expenditure during that short life.
Property investment depreciation can be quite difficult to measure due to restrictions in the availability of property market data but there have been a number of studies trying to measure depreciation rates across different commercial property sectors. This includes a series of studies sponsored by the Investment Property Forum (IPF). They suggest that the rental value of offices depreciates by very approximately 1% per year against a new building but also need around 1% of the capital value spent each year to keep depreciation down to this rate.