Instances when the value of land depreciates

Is there a difference between inflation and appreciation? This question arises from the comment I made last week regarding the price of land: we never talk about inflation when prices of land go up. Instead, we call it appreciation.

The easiest way to understand it is that inflation applies to prices of consumables and appreciation to the prices of assets. The reverse of inflation is deflation while that of appreciation is depreciation.

Accountants like to depreciate the value of an asset to account for the fact that, once purchased, it is no longer as good as a new one. If you buy a brand new car from the showroom today (not a used import!), there is a good chance that the moment you finish signing the purchase agreement, its value will drop by 10 per cent!  This is the amount you are likely to pay for breach of contract if you change your mind.

Then the moment you drive it out of the showroom, you can knock off another 10 per cent from the original buying price. The total so far is 20 per cent. In other words, if the car cost you Sh3m, you are now likely to get only Sh2.4m for it – Sh2.5m at best!

If that sounds bad, take the case of computers. Every five years, there is a major shift in technology that renders many software programmes obsolete. Consequently many people have to throw away theirs and buy new ones. So, every year, the value of such software sheds 20 per cent of the purchase price. In five years, it is worth zero shillings!

But about land: does it depreciate? There is a saying in my language that “tiri ndugumaga”; that is, “soil does not rot”. I guess this is what has made my tribesmen mad about land! Nevertheless, land can depreciate depending on the type of title it has.

If you own land on a free-hold title, then it is yours for ever and ever, amen.

However, if it is lease-hold, then your ownership is only for the period stipulated on the certificate. In most cases, it is for 99 years.

IT DEPRECIATES

Thus if you pay Sh500,000 for a plot which has a 99-year lease starting from, say 1965, you will only own it up to the year 2065. After that, ownership will revert to the original holder – most likely, the county or national government.

That is, you are buying ownership for 50 years only. Therefore, its true value (what accountants call book value) depreciates by Sh10,000 every year. The market value, however is a different kettle of fish.

It is unfortunate, though, that many people never look to find out the period remaining on the lease of the plot they are buying. They assume it is theirs for ever and so they are willing to pay premium prices for it.