Valuation and Market Analysis exam concept
The three types of appraisal depreciation
A roof can wear out, a sound floor plan can work badly, and a well-designed house can lose appeal because of noise next door. Those are different sources of value loss. Identify the cause first. Then decide whether correcting it makes economic sense.
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The short answer
The three appraisal depreciation categories are physical deterioration, functional obsolescence and external obsolescence. Physical deterioration concerns wear or damage. Functional obsolescence concerns the property's own design or utility. External obsolescence comes from outside influences. Curable and incurable describe whether correction is economically feasible; they are not additional causes. In a cost-approach problem, deduct the supported depreciation from improvement cost new, then add the separately estimated site value.
Reviewed October 24, 2026. This lesson supports National III.B.3, the cost approach, in the June 24, 2026 PSI broker outline. The whole national Valuation area accounts for 8 of 100 scored questions, not eight questions on depreciation. The figures below are original teaching assumptions, not repair estimates, appraisal adjustments or tax advice. The sources distinguish general valuation concepts from a particular lender's appraisal policies.
Classify the cause before testing the cure
- Ask what caused the loss. Worn material points to physical deterioration. An intact feature that does not meet market needs points to functional obsolescence. An adverse influence beyond the property points to external obsolescence. A feature merely being old, expensive or unpopular is not enough to establish a particular dollar loss.
- Separate location from control. A layout defect remains functional even if the owner cannot afford to correct it. Lack of control does not automatically make a problem external. Conversely, improving a house may reduce the effect of outside noise without moving its source inside the property.
- Test economic curability. Use the complete cost of correction and the supported contribution to value, with practical and legal feasibility considered. A physically possible repair can be economically incurable. A repair quote is not automatically the same figure as market value loss.
- Use the stated method and figures. For a basic cost approach, separately estimate the site value and improvement cost new, deduct the supported improvement depreciation and add the site. Keep physical, functional and external losses from being counted twice. A replacement-cost estimate that already omits an obsolete feature should not be charged again for that same excess cost.
- For a simplified age-life question, use the supplied effective age divided by total economic life. If remaining economic life is supplied, total life is effective age plus remaining life. State what the model includes before adding a separate deduction. This is not a universal annual sale-price decline or a substitute for analysis of conditions outside the model.
- For a real property, support the effect with appropriate evidence. An old roof, unusual floor plan or nearby use does not supply its own universal adjustment. Keep the source, estimated value effect and any repair or safety requirement distinct. Use qualified inspection, engineering and appraisal expertise for the tasks that require it.
| Category | What causes it | Example with value loss assumed | Curability |
|---|---|---|---|
| Physical deterioration | Worn, damaged or deteriorated material. | A roof covering that has worn out. | Can be curable or incurable; do not decide from physical repairability alone. |
| Functional obsolescence | The property's own design, layout, capacity or other utility mismatch. | An intact bedroom can be reached only through another bedroom. | Can be curable or incurable; market contribution and complete correction cost matter. |
| External obsolescence | An adverse influence outside the property. | Persistent aircraft noise causes an evidenced discount. | Usually treated as incurable by the individual owner. The outside influence can still change or end. |
The distinctions that matter
| Distinction | How it works | What to notice |
|---|---|---|
| Physical deterioration vs. functional obsolescence | Physical deterioration concerns wear, damage, or material condition. Functional obsolescence concerns inadequate or excessive design and utility within the property. | Worn out versus works poorly. |
| Functional vs. external obsolescence | Functional loss comes from the property's own utility or design, including exterior features on the site. External loss comes from influences outside the property. | The cause is the test, not whether the feature is indoors. |
| Curable vs. incurable | Curable means correction is economically justified. Incurable means correction is unavailable, outside control, or costs more than the market benefit. | Worth fixing versus not worth or not able to fix. |
| Functional inadequacy vs. superadequacy | An inadequacy provides less utility than the market expects. A superadequacy provides more costly capacity or quality than the market supports. | Too little versus economically too much. |
| Actual age vs. effective age | Actual age is time since construction. Effective age reflects observed condition and utility; it can be younger, older or the same as actual age. | Renovation can change effective age without resetting the construction date. |
| Economic life vs. physical life | Economic life lasts while the improvement contributes to property value under its use. Physical life lasts while the structure can physically remain usable. | Profitable usefulness versus physical survival. |
| Accrued depreciation vs. tax depreciation | Appraisal depreciation concerns value loss relative to the selected cost-new base. Tax depreciation concerns cost recovery under tax rules. A tax deduction is not a measured sale-price decline. | Market loss versus tax allocation. |
| Cost to cure vs. depreciation amount | Cost to cure is the expenditure required for correction. Depreciation is the value loss, which may be higher, lower, or equal depending on market reaction. | Repair bill versus value effect. |
Work through the facts
Worn roof covering
A worn-out roof covering requires replacement. The complete correction cost is $14,000. The stated market evidence supports $18,000 in added value after the correction, and the work is feasible.
- The loss comes from the material's condition: physical deterioration.
- The complete $14,000 cost is below the supplied $18,000 value benefit.
- On these assumed facts, the correction is economically justified. The $4,000 difference is not a forecast of a real owner's profit.
Answer: This is curable physical deterioration.
Settled structural foundation
An older building has major structural settlement. Stabilization would cost more than the market value it would restore, though an engineer says repair is physically possible.
- The defect concerns the building's physical structure.
- Physical possibility does not establish economic curability.
- The assumed cost exceeds the supported value benefit.
Answer: This is incurable physical deterioration on the stated economics.
Obsolete room access
An otherwise sound house requires walking through one bedroom to reach another. The market discounts that layout. A lawful, feasible reconfiguration costs $6,000 in total and is expected, on the supplied evidence, to add $10,000 in value.
- The problem is design and utility, not wear.
- The complete correction cost is less than the supplied value contribution.
- It is functional obsolescence and curable on these facts. A physically intact feature can still cause depreciation.
Answer: This is curable functional obsolescence.
Oversized commercial system
A small building contains a costly industrial mechanical system far beyond users' needs. Removal and replacement would cost more than the value gained.
- The system provides excessive capacity relative to market demand.
- The loss is a functional superadequacy.
- The cure is not economically justified on the assumed figures.
- The feature can still contribute some value. Superadequacy does not mean every dollar of its cost is necessarily lost.
Answer: This is incurable functional obsolescence.
Aircraft noise
Comparable evidence shows homes within a persistent airport noise contour sell below otherwise similar homes outside it.
- The source is outside each individual property.
- The individual owner cannot eliminate the stated airport noise source. Measures that reduce its effect do not necessarily remove every market consequence.
- Market sales provide a way to estimate the locational effect.
Answer: This is external obsolescence, commonly incurable by the individual owner.
Effective age after renovation
A 45-year-old building has been renovated. The question supplies an effective age of 18 years, total economic life of 60 years, improvement cost new of $400,000 and separate current site value of $80,000. Use the simplified age-life method with no additional separate deductions.
- Actual age remains 45 years; the problem supplies effective age of 18.
- The model's accrued-depreciation ratio is 18 / 60 = 0.30, or 30%.
- Depreciation is $400,000 x 0.30 = $120,000. Depreciated improvements are $280,000.
- Add the separately estimated site: $280,000 + $80,000 = $360,000. Do not depreciate the combined $480,000 cost-plus-site amount by the building ratio.
Answer: The simplified cost-approach indication is $360,000 on the supplied assumptions. Do not add another deduction for a loss already included in the model.
Mistakes to avoid
- Old automatically means physical deterioration. An intact but outdated design can cause functional loss. Identify wear separately from utility.
- An owner cannot fix it, so it must be external. An expensive structural repair remains physical; an expensive layout change remains functional. Control and economics do not replace cause.
- Curable means physically repairable. Check economic feasibility and the complete correction cost. A possible repair can cost more than the value it adds.
- A more expensive feature always adds its full cost in value. A superadequacy can contribute less than its cost. The amount requires evidence; it is not automatically zero.
- Every nearby airport or business causes the same loss. Use evidence of the particular influence and market reaction. Proximity alone does not establish a universal adjustment.
- Incurable means permanent. An outside influence can be temporary or cyclical even when one owner cannot cure it.
- Land can never lose value. Do not apply the building's depreciation ratio to the site. Estimate current site value separately; that value can reflect adverse market or location conditions.
- A cost-approach depreciation amount is the tax deduction. The purpose, base and method differ. Do not use a recovery schedule as evidence of market loss.
- A loss can be deducted in every category it seems to touch. The same value effect must not be counted twice. Identify the model's scope and what the supplied deductions already include.
Check your understanding
These are original teaching questions, not recalled or predicted PSI questions. Answer first, then explain why the other choices fail.
1. The stated value loss comes from worn roofing and peeling paint. Which cause fits?
- Physical deterioration
- Tax cost recovery
- External obsolescence
- Functional obsolescence
Show answer and explanation
Answer: A. Physical deterioration
The question identifies material wear. It does not identify an intact but inadequate design or an outside influence. The category alone does not establish whether the repair is economically curable.
2. An intact house is discounted because the only access to one bedroom is through another. What causes the depreciation?
- Physical deterioration merely because the house is older
- A tax recovery period
- Functional obsolescence
- External obsolescence because buyers dislike the layout
Show answer and explanation
Answer: C. Functional obsolescence
The loss comes from the property's layout and utility. Buyer preferences help establish its market effect; they do not turn the source into an outside condition. Physical damage is not stated.
3. Otherwise comparable evidence supports a value loss from persistent aircraft noise originating outside the property. Which category fits?
- Deferred maintenance by the owner
- Functional inadequacy inside the house
- External obsolescence
- Physical deterioration of the roof
Show answer and explanation
Answer: C. External obsolescence
The cause is an outside influence. The facts supply a market effect rather than assuming every airport-adjacent property suffers a fixed loss. It is usually beyond the individual owner's ability to eliminate.
4. A feasible correction costs $8,000 in total and is supported to add $15,000 in value. What does the economic test indicate on those facts?
- Curable depreciation
- A guaranteed $15,000 cash profit
- External, regardless of the original defect
- Incurable, because every correction has a cost
Show answer and explanation
Answer: A. Curable depreciation
The complete cost is below the supplied contribution to value, so correction is economically justified on the assumptions. The figures do not identify the cause category by themselves or guarantee realized proceeds or profit.
5. A building was constructed 30 years ago and renovated. The question supplies an effective age of 10 years. Which age remains 30?
- Remaining economic life
- The tax recovery period
- Effective age after every renovation
- Actual or chronological age
Show answer and explanation
Answer: D. Actual or chronological age
Actual age measures time since construction. Renovation can support a different effective age but does not change the construction date. Neither remaining life nor a tax period is supplied by the 30-year construction age.
6. Use the simplified age-life method: effective age 18 years, total economic life 60 years, improvement cost new $400,000 and separate current site value $80,000. No other deductions apply. What is the cost-approach indication?
- $336,000
- $120,000
- $360,000
- $280,000
Show answer and explanation
Answer: C. $360,000
18 / 60 = 30% depreciation. $400,000 - $120,000 = $280,000 in improvements; add $80,000 site value to get $360,000. $336,000 wrongly applies 30% to the building-plus-site amount. $120,000 is the deduction; $280,000 omits the site. The question supplies total life, so do not treat 60 years as remaining life or substitute the building's calendar age.
7. An intact, obsolete floor plan causes value loss. Correcting it would cost more than the value added. How should both questions be answered?
- Curable physical deterioration because reconstruction is possible
- External obsolescence because the owner cannot afford it
- Incurable functional obsolescence
- No depreciation because the materials are intact
Show answer and explanation
Answer: C. Incurable functional obsolescence
The source is the property's utility, so it is functional. The supplied economics make it incurable. Physical intactness does not eliminate functional loss, and an uneconomic cure does not turn the internal design problem into an external cause.
Common questions
What are the three types of depreciation in real estate?
Physical deterioration, functional obsolescence and external obsolescence are the three broad appraisal causes. Think material condition, the property's own utility, and outside influence. Curable versus incurable is a separate analysis of correction, not a fourth cause.
What is physical deterioration?
It is loss associated with the improvement's wear or damage. Worn roofing, decay and deteriorated components are common teaching examples. The question still needs facts about economics before you can call the particular item curable or incurable.
What is functional obsolescence?
It concerns the improvement's design or usefulness relative to market needs. A sound but awkward layout, deficient capacity or excessive feature can cause it. Functional does not mean only indoors: a property's own site layout or parking capacity can present a utility issue too.
What is external or economic obsolescence?
It is loss caused by adverse influences outside the property. Noise, incompatible neighboring uses or a demonstrated broader demand decline can be examples. The owner usually cannot eliminate the source alone. External and economic are often paired in this exam vocabulary.
How do I decide whether depreciation is curable?
Compare the complete, feasible correction cost with the supported contribution to value. A cost below the added value points to an economically justified cure in a basic question. Being physically repairable is not enough. Real analysis also considers scope, timing, feasibility and market evidence.
Is external obsolescence always permanent?
No. Its source can be temporary, cyclical or persistent. An owner's inability to eliminate the source does not mean it can never change. Do not confuse the duration of the influence with whether one owner can economically cure it. Incurable is an appraisal classification, not approval to ignore an otherwise applicable safety, repair or lending requirement.
What is a superadequacy?
It is a feature whose excessive quality, size or capacity is not fully supported by the market. It can create functional obsolescence even if it is in excellent physical condition. A feature may still add some value while adding less than its cost.
Can a property have more than one type of depreciation?
Yes. Worn roofing can cause physical loss, an intact awkward layout can cause functional loss, and outside noise can cause external loss at the same property. Identify distinct effects and avoid deducting the same value loss twice. A single feature can also have both wear and a utility problem; read which cause the question isolates.
Is repair cost the same as depreciation?
Not automatically. The repair bill measures expenditure; depreciation concerns the supported value effect. They may coincide in a specified method or example, but one figure does not universally establish the other. Include related work when the question asks for the complete cost to cure.
What is actual age versus effective age?
Actual age counts years since construction. Effective age reflects observed condition and usefulness. A renovated older building can have a younger effective age, and a neglected newer one can have an older effective age. Use the figure the question supplies for the stated method.
What is the age-life depreciation formula?
For the simplified model, accrued depreciation percentage = effective age / total economic life. If remaining economic life is supplied, total economic life = effective age + remaining economic life. Apply the resulting percentage to the stated depreciable improvement cost, not the separately valued land. Do not double-count a loss already included in the model.
Can land lose value if it is not depreciated like a building?
Yes. In the basic cost approach, value the site separately at the appraisal date, then add depreciated improvements. That site estimate can reflect adverse location or market conditions. The instruction not to apply a building depreciation rate to land is not a promise that site values only rise.
Is appraisal depreciation the same as income-tax depreciation?
No. Tax depreciation recovers qualifying cost under tax law. Appraisal depreciation concerns value loss under the valuation method. A property can rise in sale price while deductions are claimed or while its improvements remain below current cost new. This lesson does not calculate a taxpayer's deduction.
Does depreciation mean the property sold for less than the owner paid?
Not necessarily. Current cost new, site value and market conditions can differ from those at purchase. A deduction from today's improvement cost does not by itself establish the change in the whole property's sale price since acquisition.
Are these official PSI questions?
No. These are seven original teaching scenarios reviewed October 24, 2026. They support the national Valuation topic and are not recalled or predicted PSI items, an appraisal report or a validated measure of exam readiness.
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Official sources and scope
Reviewed October 24, 2026. The California regulator reference and IAAO glossary support general appraisal vocabulary, not California licensing rules as Illinois law. HUD's published chapter supplies the three-cause framework; its specialized health-care underwriting requirements are not imposed on an Illinois broker exam candidate. Fannie Mae supplies its own lending guidance, not a universal appraisal adjustment. The former HUD draft/redline citation has been replaced. No full USPAP compliance review, professional appraisal or individualized tax calculation is claimed. Original examples supply feasibility and market effects where needed; they do not infer a value loss or guaranteed repair return from age or proximity alone.
- PSI Illinois booklet, June 24, 2026: National III.B.3 cost approach within the 8% Valuation area
- California DRE Reference Book, chapter 15, printed pages 406-412: general cost approach, depreciation and age-life teaching
- HUD Section 232 Handbook, section II, chapter 5, section 5.3.N: three causes and remaining economic life
- IAAO Glossary, third edition: depreciation, functional and external obsolescence, effective age and superadequacy
- Fannie Mae B4-1.3-10, June 4, 2025: consistency of cost-approach analysis with identified functional and external conditions
- IRS Publication 946, 2025 edition, chapter 1: tax depreciation as cost recovery; used only for that distinction
This is exam preparation, not advice for a specific transaction. State law and the applicable facts control. Our editorial and corrections process explains how to report an issue.