Property Depreciation: What Causes It And How It Can Affect You

Properties that depreciate in value can have serious financial consequences for their owners, particularly if the purchase was financed through a loan

Property Depreciation: Buying a house is one of the most expensive purchases that most of us may make in our lifetime. Real estate, in general, is conventionally viewed to be a secure investment, with the assumption that property values will appreciate over time. However, property values can also depreciate due to various factors. Properties that depreciate in value can have serious financial consequences for their owners, particularly if the purchase was financed through a loan. Let's look at the key factors that influence property value and their potential impact.

Factors Leading to Property Depreciation

1. Market trends 
Real estate markets are cyclical, which means prices can rise and fall. Short or long-term negative sentiments like an economic downturn, political instability, and job market instability may affect property prices. Moreover, events like the Covid-19 pandemic, change in government policies, new tax rules, or poor maintenance of the house or housing society are some reasons that contribute to property prices remaining stagnant for a long period or depreciate. 

2. Declining neighbourhood  
You purchase a property that has been sold with future promises of good road connectivity, reliable water and electricity supply, and commercial development in the neighbourhood. However, a few years down the line, none of those promises have been fulfilled and instead you are faced with poor infrastructure, rising crime, and increased pollution. In such a scenario, the likelihood of property values declining increases significantly.

3. Change in government policies 
Government policies related to land acquisition, zoning laws, or tax reforms can affect property values. Major infrastructure projects, such as the construction of a metro or airport, can also influence property values.

4. Oversupply of real estate 
A higher supply of houses but lower demand can also lead to a decrease in property value. However, in India, with its extensive population, the situation is usually reversed - higher demand for properties with buyers expecting some return on their investment.

Financial implications of property depreciation 

Impact on net worth
The immediate impact of depreciation in a house's value is on your net worth. For most people, a house is often the largest asset in their portfolio, and a reduction in its value directly reduces personal wealth. For instance, you purchased a house worth Rs 50 lakh, but its current market value has depreciated by 20 per cent. Here’s how it affects your net worth:

Original house value: Rs 50,00,000
Depreciation @ 20%: Rs 50,00,000 × 20% = Rs 10,00,000
Revised house value: Rs 50,00,000 – Rs 10,00,000 = Rs 40,00,000

Due to depreciation, you end up losing Rs.10,00,000 and the revised value of your house is Rs.40,00,000. This depreciation will directly lower your overall net worth.

Loan-to-Value Ratio (LTV)
When you take a home loan, the loan-to-value ratio (LTV) is a critical measure used by banks to determine how much money they are willing to lend. If the value of the property falls, your LTV ratio increases, which can lead to lower value offerings if you plan to refinance or sell the property.

Challenges in selling the property
A property that has depreciated in value may be challenging to sell. In a market where property values are falling, it can take time to find a buyer willing to pay your desired price or you may even have to sell at a significant loss. 

For instance, you have purchased a house worth Rs 50,00,000 with the help of a loan. You made a down payment of Rs 10,00,000 for the house while the bank loaned you Rs 40,00,000. The house depreciated in value by 20 per cent. Post-depreciation, this will be the value:
• Revised house value: Rs 50,00,000 – Rs 10,00,000 = Rs 40,00,000
• Outstanding Loan: Rs 40,00,000
• Net Equity: Rs 40,00,000 (House value) – Rs 40,00,000 (Loan) = Rs 0

This example above highlights how the depreciation and cost of the loan lead to zero appreciation in the house's value. You may be at risk of negative equity if the value depreciates further. 

Real estate is considered a safe investment that yields return on investment. But, many factors can affect this, leading to an unfavourable outcome. So, before purchasing a property, make sure you have a financial checklist and don’t forget to account for depreciation. 

The author is the AGM, communication at Bankbazaar.com. This article has been published as part of a special arrangement with BankBazaar.