Comparing effective age vs. economic life is an essential concept to understand for real estate professionals and appraisers. In this article, we define economic life, effective age, and actual age and compare the differences in terms.
What is Economic Life?
Economic life is the specific amount of time in which a piece of property can be put to profitable use.
Economic life is usually less than its physical life. And that makes sense, right? A rundown mall still exists or has a physical life but no economic life due to something like physical deterioration. When an asset or piece of real estate is no longer valuable to its proprietor, it is said to be past its economic life.
What is Effective Age?
Effective age is the age of a property based upon its utility, condition, and physical wear and tear, not its actual age.
The effective age is one of the many appraisal concepts appraisers use to determine fair market value for a property. Using the effective age, geographic location, comparable properties, real estate market trends, and more, appraisers can accurately determine a fair price for properties.
What is Actual Age?
Actual age is pretty self-explanatory; actual age is the total years that have passed since a structure was built.
Sometimes actual age is also referred to as the chronological age on the real estate exam.
What is Actual Age vs Effective Age?
Suppose an appraiser analyzes a structure that is 20 years old, but because the owner kept excellent care of the property, it has the condition of a 10-year-old building. In that case, the appraiser may use the 10-year-old age as the property’s effective age.
Obviously, things can flip as well. Suppose an appraiser analyzes a property that is 10 years old, but the owner takes poor care of the property; it has the condition of a 20-year-old building. Again, in that case, the appraiser may use the older age as the effective age.
Effective Age vs Economic Life
Appraisers take the difference between an economic life of a structure and the remaining economic life of that structure to find its effective age. Depending on the situation and circumstance, the effective age may be more, less, or the same as the actual age.
How Do I Find the Economic Life Remaining Economic Life of My House?
There are several ways to find economic life.
The most common method is to start by looking for some comparables. Ideally, the comparables appraisers use should be very similar in terms of age and condition. With those properties, it’s essential to deduct depreciation or find properties similar without any depreciation.
Once you have a solid set of comparable sales, you deduct the land’s value from each sale’s sales price. That way, you develop a reliable opinion of the property’s value. Once you remove the land value from the sales price, the home’s depreciated cost remains.
After that, you look at how long it took for the home to depreciate; with your depreciation percentage, you can find your total economic life.
For most of our readers, you won’t need to do the economic life math on the real estate exam, so don’t worry. But for those becoming an appraiser, here’s a step-by-step guide on the math behind economic life; check out How Remaining Economic Life Works.
What to Know for the Real Estate Exam
When exam day comes, you need to be familiar with effective age, actual age, economic life, and its relationship with each other. Remember, actual age is the total years that have passed since a structure was built. Effective age is the age of a property based upon its utility, condition, and physical wear and tear, not its actual age. Lastly, economic life is the specific amount of time in which a piece of property can be put to profitable use. If you understand these three concepts and their respective relationships, you’ll be good to go come exam day!