Mark Twain once said, “Buy land; they're not making any more of it.” This famous saying implores the importance of real estate investing, which is seemingly simple yet yields tremendous results. For as long as we know, land assets have been known to be irreplaceable. Land cannot be created nor destroyed, which makes it wealth generating asset. Land-based assets are known to appreciate over time. No matter how far we go, the land has shown appreciation in its value during every decade.
Minor things like economic recession might affect the appreciation rate temporarily, but the price always comes back to its former glory with more vigor.
What Is Appreciation In Real Estate?
Assets such as cars, boats, electronics, furniture, and real estate properties have a strong inclination to appreciate with time. This phenomenon is partly due to inflation, but the main reason is behind the concept of supply and demand. Unlike furniture and cars, we cannot build land anymore. Thus, as the demand for free land increases, the rate of such land will keep on increasing.
According to the National Association of Realtors, the average price of a house has risen by 6.4 percent in the US per year between the years of 1968 and 2004. Home values experienced a sharp dip during the 2008 depression but has since recovered and is showing its former trend. (source)
Real estate appreciation can be categorically defined as;
“The rise in the price of the property over some time. One of the reasons to invest in real estate properties is to get a profit on your investment once you decide to sell your property in the future.”
There are further classifications of real estate appreciation, which will be discussed in the following paragraphs.
Types of Real Estate Appreciation
This concept of the increase in value over time of land and real estate is known as appreciation. There are two significant types of appreciation; the first one is natural appreciation, and the second one is forced appreciation. The significant difference between these two types is the control and speed at which the value of the land appreciates.
Natural Appreciation in real estate
Let's imagine your family owns a home in which you have spent all your life. Almost every house in the USA is worth more than it was 30 years from now. And there are several examples you will find where the value of a home tripled in value throughout a couple of decades.
This appreciation is known as natural appreciation. The owner or investor does not control it. The land will appreciate over some time due to the simple concept of supply and demand. As the population grows and development is expanded to each corner of the world, the demand for land is increased, and due to its shortage, its rate is increased.
In natural appreciation, population growth is the driving force behind the increase in the sticker price of a land piece. As demand increases, the need for land is also increased. This factor drives the rate of this land to rise.
Forced Appreciation in real estate
Forced appreciation is the hidden weapon of any short-term real estate investor. To take advantage of this phenomenon, real estate investors buy a small piece of land, a small house, or maybe even a large housing complex, and increase its value by using many ways. No matter what method you use to force an appreciation, the goal should be to increase the price of the property you own. Forced appreciation is the only one of the two kinds of appreciations that allows investors to control the rate and appreciation scale.
A great example of investors taking advantage of forced appreciation is a fix-and-flip. This is an investment strategy in which a house is bought for the single purpose of fixing it by infusing capital on said property to improve various aspects of the property. This action is done to improve the value of the property by forcing an appreciation on said property.
Renovations can significantly improve the appreciation rate of a property. Features like revamped kitchen, improved deck, and overall refurbishment of a property can induce forced appreciation. These upgrades are strategically applied to make the most out of your investment. A by-product of an investment in a home is the rent increase, improving your monthly influx of cash.
Which Kind of Appreciation is Better?
When it comes to appreciation, you are not restricted to choose one or the other. Some of the most successful real estate agents take advantage of both natural and forced appreciation. Several investors in the real estate investment industry want a property located in a posh locality where there is room for improvement. When an investor finds a property where there is room for improvements, they can force appreciation on that property by fixing and upgrading it. This step is even more effective when the property you invest in is located in a posh location.
Moreover, an investor is much more likely to receive natural economic appreciation at a much quicker pace if it is located in an A or B locality. The property lies in a B or C class. This helps a lot, as local renovated comps perform much better here.
This suggests that the market delivers results on properties that would be similar to our investment after upgrades. This whole scenario gives you an idea of how the market will behave and what will the scale of your rental income, which has a direct impact on your property’s appreciation. Never choose one option when you have the luxury to have both.
Strengthen Your Future with Appreciation of Real Estate
An excellent way to begin your investment journey is with properties that have some room for improvements. These properties are called value-add properties. These properties generate opportunities for investors to take advantage of forced appreciation. As a novice investor, learning how to improve a rental property will generate more rent per unit. Hence, the annual rental income is directly improved. This increase in income will lead to a total increase in operating income. The purchasing rate is calculated by dividing the NOI by the cap rate.
If improvements on a property are made right, then it will lead to higher rent generation and, consequently, an increase in rental income. This increase in rental income will force appreciation on that property. Like any other business venture, increasing the net gains while maintaining your expenses will make your property more profitable.
The driving force behind the increased rent generation is short-term appreciation. If a value-add property is selected strategically in a location where the value of the property will appreciate over time, then the investor will be able to reap the advantage of both natural and forced appreciation. This investment strategy is the key to generational wealth and long-term continuance of an income stream—this way, an investor can earn and reap benefits on their investments even in their sleep.
Factors that Determine Real Estate Appreciation
Real estate investors are always looking for properties they can invest in. Especially those which they know will appreciate in a few years. Such investments can become a source of financial stability and security for the future. Land appreciation also offers the luxury of selling your current property at a higher rate than what you paid to buy something bigger. Several factors can affect the appreciation of the land. These factors are:
1. Supply and Demand
Supply and demand is a natural phenomenon that is found in this capitalistic world. When the demand for homes rises, the prices of these homes also jump up. The price of homes will keep on increasing until newer residential houses are not built.
An increase in demand gives rise to the attention of real estate investors in that particular area. These investors make a living by buying and building homes and selling it at a higher rate. In the end, buyers are willing to pay higher rates for houses that meet their fancy to beat any other buyer who are in the race for the same house.
The location of a property is key when it comes to price appreciation. Buyers are often looking for properties that are in posh areas of the city. Ideally, if you are looking to invest in real estate, you want a B or C category property in an A or B category locality. Real estate investors are looking to invest in areas where there is a higher probability of development around the state's property.
Profitable markets, amenities, and infrastructure attract more investors and, consequently, more buyers for the property in question. Such properties are more in demand due to their lively and cultural vibe and proximity to workplaces and other local establishments like parks, hospitals, markets, and shopping malls.
Owning such property is nothing less than sitting on a gold mine. Such properties appreciate over time and reward heavily in the future. Buyers are willing to buy such properties at a higher rate to be a part of that community and take advantage of local amenities.
3. Property Market Drivers
Price appreciation of real estate is affected by any development in the vicinity of the property that positively affects your property. While the home's structural integrity and overall condition greatly affect the appreciation rate on your property, you also need to keep an eye out for government projects and upcoming infrastructure in the area.
These are called property market drivers. Potential property drivers can be many things like; rail, road, or airport; new office complexes; construction of a shopping mall or hypermarket; and proximity to schools, universities, hospitals, restaurants, etc.
Buying property in such locations can be very beneficial as such properties will increase value once such projects come to fruition.
4. Cost of Borrowing
The expense of borrowing at any instant greatly influences the property market, just as land appreciation. When the cost of borrowing is costly, i.e., high financing costs, the interest in houses will decay because fewer individuals will have the option to bear costly credits.
Additionally, when the cost of borrowing is reasonable, for example, low financing costs, there will be a more appeal for private properties since more purchasers will have the option to bear the cost of the less expensive advances. Likewise, when the Federal Reserve loosens up loaning rules, a larger part of potential purchasers will fit the bill for credit offices, which will expand the interest for private houses and, eventually, raise the estimation of properties.
Conclusion – Appreciation In Real Estate
Real estate appreciation is the rise in the cost of a piece of land over a certain period. This can happen naturally or, if you want, you can induce it artificially, known as forced appreciation. Several factors can affect the appreciation of your home. The main difference between natural appreciation and forced appreciation is that you have more control over the speed and scope of appreciation in forced appreciation. Genuine appreciation occurs due to the high demand for property and less supply; this phenomenon spikes the rates of properties in due time.
On the other hand, forced appreciation has more to do with what you do than what the demand is right now. You can force an appreciation on a property in several ways. Little things like landscaping and painting the outside of your home can have a huge effect on the cost of your home as well as the rent on that building.
Forced appreciation is considered a secret weapon for short-term land investors who earn from the difference between what they have spent on the property to the rate the property has been sold.