What is 'Economic Depreciation'

Economic depreciation is a measure of the decrease in value of an asset over time. This form of depreciation usually pertains to real estate, which can lose value due to indirect causes such as the addition of new construction in close proximity to the property, road additions or closures, a decline in the quality of the neighborhood, or other external factors. Economic depreciation is different than depreciation expense on tangible assets, such as machinery or equipment.

BREAKING DOWN 'Economic Depreciation'

In periods of economic downturn or a general housing market decline, economic depreciation must be considered when a property goes through an appraisal. During the credit crisis and housing market collapse of 2008, the combination of subprime loans requiring low or no down payments with the dramatic drop in housing values resulted in a significant amount of the U.S. home owners owing more money on a home than it was actually worth.

Factoring in Liquidity

Real estate’s lack of liquidity makes the impact of economic depreciation more profound for the owner. Liquidity refers to the ability of an owner to sell an asset, and assets that sell on exchanges, such as stocks and bonds, are more liquid than real estate and other assets. If, for example, an investor wants to sell 100 shares of IBM common stock, that investor can check the bid price on a stock exchange and place a trade to sell the stock on any business day. Real estate, on the other hand, requires the seller to find a buyer, and the two parties must negotiate until the parties agree on a price. In addition, the sale normally requires an appraisal of the property, and a real estate sale can take months to complete.

Differences Between Tangible and Intangible Assets

Economic depreciation is different than the depreciation recognized for tangible assets as those assets are used to create revenue. While land does not depreciate, buildings and other tangible assets do recognize depreciation, which is the decline in value of a physical asset as the asset is used over time. Assume, for example, that a roofing company uses a truck to perform residential roofing work, and that the truck is used for seven years. As the truck is used each year to generate revenue, the company also posts depreciation expense for the decline in value of the asset. Intangible assets, such as a patent or other intellectual property, do not depreciate in value.

RELATED TERMS
  1. Depreciable Property

    Any type of asset that is eligible for depreciation treatment. ...
  2. Appraisal Method Of Depreciation

    A form of depreciation calculation that is based upon appraisal ...
  3. Accumulated Depreciation

    The cumulative depreciation of an asset up to a single point ...
  4. Carrying Value

    An accounting measure of value, where the value of an asset or ...
  5. Salvage Value

    The estimated value that an asset will realize upon its sale ...
  6. Declining Balance Method

    A common depreciation-calculation system that involves applying ...
Related Articles
  1. Investing

    How Rental Property Depreciation Works

    It's a bit tricky, but a valuable tool to make your investment pay off.
  2. Investing

    An Introduction To Depreciation

    Companies make choices and assumptions in calculating depreciation, and you need to know how these affect the bottom line.
  3. Investing

    Explaining the Declining Balance Method

    The declining balance method is a system for calculating an asset’s rate of depreciation against its non-depreciated balance.
  4. Investing

    Understanding Carrying Value

    Carrying value is the value of an asset as listed on a company’s balance sheet. Carrying value is the same as book value.
  5. Trading

    Understanding Currency Depreciation

    Currency depreciation occurs when a currency’s value falls in comparison to other currencies.
  6. Investing

    Double Declining Balance Depreciation Method

    The double declining balance depreciation method counts the depreciation of a long-lived asset’s book value at double the rate of its straight-line depreciation.
  7. Taxes

    Filling Out Form 4562: Investopedia Explains

    Step-by-step, how to fill out the depreciation and amortization form for your business tax return.
  8. Taxes

    Recoverable Depreciation: How it Works

    Recoverable depreciation is a concept used in many insurance policies and claims.
  9. Investing

    Depreciation: Straight-Line Vs. Double-Declining Methods

    Appreciate the different methods used to describe how book value is "used up".
RELATED FAQS
  1. Is depreciation only used for tangible assets?

    Learn if tangible assets can be depreciated, as well as what other assets are eligible for depreciation so you can account ... Read Answer >>
  2. What tangible assets are depreciated?

    Learn about why tangible business assets are depreciated, what qualifies as a tangible business asset and which assets cannot ... Read Answer >>
  3. Can real estate be depreciated?

    Decrease the amount of taxable income on your income-producing real estate by depreciating the asset on your federal income ... Read Answer >>
  4. What is the relationship between accumulated depreciation and depreciation expense?

    Understand the relationship between accumulated depreciation and depreciation expense. Learn how each one is accounted for ... Read Answer >>
  5. How is depreciation related to the carrying value of a tangible asset?

    Understand how depreciation is related to the carrying value of a company's tangible asset. Learn how accumulated depreciation ... Read Answer >>
  6. What would cause a decrease in accumulated depreciation?

    Understand what causes a decrease in a company's accumulated depreciation. Learn why a company's accumulated depreciation ... Read Answer >>
Hot Definitions
  1. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  2. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  3. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  4. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  5. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
  6. Impaired Asset

    A company's asset that is worth less on the market than the value listed on the company's balance sheet. This will result ...
Trading Center