Real estate appreciation can be an incredibly powerful tool for creating wealth and achieving financial freedom. Understanding how to effectively use real estate appreciation is essential for anyone looking to get the most out of their real estate investments. In this blog post, we will discuss the fundamentals of real estate appreciation and how to maximize your returns. We’ll look at what appreciation is, some of the key benefits of real estate appreciation and provide tips and strategies for making the most of it. Whether you’re a veteran real estate investor, or new to the world of real estate, this ultimate guide will provide you with the essential information you need to become a successful real estate investor maximizing appreciation. Let’s begin.
What is Appreciation?
Real estate appreciation is an increase in the value of an asset, such as a home, building, or land, due to market forces and other factors.
When a property appreciates, its value increases over time, often due to factors such as increasing demand, inflation, and improvements made to the property. Appreciation can also occur due to changes in the local economy, population growth, and more.
Two Types of Appreciation
I break down appreciation into two distinct types: organic and forced.
Organic appreciation is the appreciation from the property’s tendency to increase in value over time. This is largely driven by inflation and demand. While it is not caused by the owner per se, investors can choose properties that are more likely to see organic appreciation.
Forced appreciation is the appreciation caused by buying a property at a discount or improving the property to add value. Forced appreciation is often caused by the investor’s actions: negotiating discounts at purchase and/or improving the property through physical improvements and/or improvements to how the property is being used and the income being produced by it.
Is Appreciation Always Positive?
So, do properties always appreciate and go up in value? In a word: no.
Sometimes, a property sells and then demand for that property or real estate market/location can decline over time reducing the value of the property.
Appreciation is not guaranteed. So, understanding appreciation can be a critical factor in your success as a real estate investor.
Appreciation: Just One Area of Return
Appreciation is just one of the 5 areas of return on a rental property.
The other four areas are:
- Cash Flow
- Debt Paydown
- Depreciation (also often referred to as Cash Flow from Depreciation™)
- Return from Reserves
The top half of the Return Quadrants™ (which includes appreciation and cash flow) are the returns that are more speculative in nature and require the market to perform for you to get them.
The left half of the Return Quadrants™ (which includes appreciation and debt paydown) are the cash later returns that tend to build up equity in the property over time.
Historical Home Price Appreciation
There are several ways to measure home price appreciation. One of the most popular is to wait for a property to sell twice and look at the change in price between the two sales and annualize it to calculate how much the property changed in value per year. Two economists, Case and Shiller, have compiled a massive amount of data and can show up what the historical appreciation rate has been for the entire US.
However, realize that seeing the appreciation rate for the entire US is not going to appropriately reflect what the appreciation rate will be in your state, your city and, even more specifically, your property. Appreciation can vary property to property in the same city. This makes sense… imagine a property in a prime location in your city. Might you expect that property to go in value more than a property still in your city, but in a much less desirable location?
How to Calculate Appreciation
Calculating appreciation is pretty straightforward:
Let's walk through calculating Appreciation for Typical 25% Down Payment Gainesville, Florida Rental Property.
First, there's organic appreciation and forced appreciation.
Organic appreciation is the tendency that properties become more expensive over time. Some would argue that, at least part of it, is from inflation.
Ultimately, to calculate the organic appreciation we will need the current value of the property and Appreciation Rate.
Both the current value of a property and the appreciation rate are easy since they both are primary inputs that do not require any real calculation.
That means that we're estimating Typical 25% Down Payment Gainesville, Florida Rental Property will naturally and organically appreciate $7,834.26 over a full year.
Forced appreciation from buying a property at a discount and/or improving the property to add value.
|After Repair Value
That means that we're estimating Typical 25% Down Payment Gainesville, Florida Rental Property was forced to appreciate $0 by buying at a discount and/or improving the property in the next year.
It is not uncommon to have zero or even negative forced appreciation on a property when acquiring it. In fact, sometimes we deliberately trade the short-term benefit of buying a property at a discount to select a property that is likely to see better than average organic appreciation in the long-term. Think of this as: selecting a high quality, in-demand property that is likely to continue to increase in demand in the future and grow faster than inflation and other properties in different areas or with different characteristics.
The total appreciation is the sum of the estimated organic appreciation and the estimated forced appreciation over the next year.
For Typical 25% Down Payment Gainesville, Florida Rental Property we're estimating the organic appreciation of $7,834.26 plus the forced appreciation of $0 gives us an estimated total appreciation of $7,834.26 in the next year.
Appreciation in Deal Analysis
When analyzing which investment property to purchase, most real estate investor use a deal analysis spreadsheet like The World’s Greatest Real Estate Deal Analysis Spreadsheet™ for example.
The spreadsheet does automatically calculate for you how much depreciation your potential investment will get based on your assumption about Appreciation Rate.
For example, appreciation is the blue bars in the Return in Dollars Quadrant™ – Year 1 section of the spreadsheet.
It is also represented as a percent in the Return on Investment Quadrant™ – Year 1 section as well. It is still the blue section at the bottom of each stacked column.
To have the appreciation calculated for you, just download a copy of the spreadsheet for free.