Characteristics of Depreciation in Commercial and Multifamily Property: An Investment Perspective

38 Pages Posted: 14 Nov 2018

See all articles by Sheharyar Bokhari

Sheharyar Bokhari

Massachusetts Institute of Technology (MIT)

David Geltner

Massachusetts Institute of Technology (MIT); MIT Center for Real Estate

Date Written: Winter 2018

Abstract

This article reports empirical evidence on the nature and magnitude of real depreciation in commercial and multifamily investment properties in the United States. The article is based on a much larger and more comprehensive database than prior studies of depreciation in such properties, and it is based on actual transaction prices rather than appraisal estimates of property or building structure values. The article puts forth an “investment perspective” on depreciation, which differs from the tax policy perspective that has dominated the previous literature in the United States. From the perspective of the fundamentals of investment performance, depreciation is measured as a fraction of total property value, not just structure value, and it is oriented toward cash flow and market value metrics of investment performance such as internal rate of return and holding period return. Depreciation from this perspective includes all three age‐related sources of long‐term secular decline in real value: physical, functional and economic obsolescence of the building structure. The analysis based on 107,805 transaction price observations finds an overall average depreciation rate of 1.5%/year, ranging from 1.82%/year for properties with new buildings to 1.12%/year for properties with 50‐year‐old buildings. Apartment properties depreciate slightly faster than nonresidential commercial properties. Depreciation is caused almost entirely by decline in the property's current real income, only secondarily by increase in the capitalization rate (“cap rate creep”). Depreciation rates vary considerably across metropolitan areas, with areas characterized by space market supply constraints exhibiting notably less depreciation. This is particularly true when the supply constraints are caused by physical land scarcity as distinct from regulatory constraints. Commercial real estate asset market pricing, as indicated by transaction cap rates, is importantly related to depreciation differences across metro areas.

Suggested Citation

Bokhari, Sheharyar and Geltner, David, Characteristics of Depreciation in Commercial and Multifamily Property: An Investment Perspective (Winter 2018). Real Estate Economics, Vol. 46, Issue 4, pp. 745-782, 2018. Available at SSRN: https://ssrn.com/abstract=3283254 or http://dx.doi.org/10.1111/1540-6229.12156

Sheharyar Bokhari

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

David Geltner (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139
United States

MIT Center for Real Estate ( email )

77 Massachusetts Avenue
Cambridge, MA 02139
United States

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