There are two ways to approach real estate investing: passively or proactively. Proactive investors are constantly looking for ways to enhance home appreciation. Passive investors, on the other hand, prefer to sit back and let the market do its thing. Property values naturally increase over time with or without investor interference, so there’s nothing wrong with taking on a passive approach.
However, if you’re the type of investor who likes taking on a more hands-on approach, you’ll be happy to know that there is plenty you can do to force appreciation out of your property. Savvy investors achieve forced appreciation mostly through strategic home improvements and optimized property management.
Whether you choose to let a home appreciate naturally, force its appreciation, or implement a combination of both, you’ll be well on your way to maximizing your returns as a real estate investor. Here’s what you need to know about home appreciation:
Market appreciation, also referred to as natural appreciation, is when home values increase in value over time. Investors buy property hoping that the home will be worth more at some point in the future. Given that future appreciation is a natural process in the real estate economy, most investors end up selling their property for more than its original purchase price.
Natural appreciation is driven by changes occurring in the real estate market that are outside of an investor’s control. Several factors affect home appreciation such as rising interest rates and persistent inflation, as we’ve seen in recent years. This happens when demand for property is high and supply is low, resulting in a favorable situation for property owners.
However, not all of these occurrences are positive. Economic factors can also negatively impact property values, resulting in a devaluation of property or stagnant growth. A sudden rise in crime rates or a mass exodus of local businesses could bring down home prices and an investor's income potential at no fault of their own. That’s why all investors should be aware of proactive ways to increase appreciation rates, regardless of their preferences.
Forced appreciation in real estate is when the value of an investment property increases as a direct result of an investor’s actions. The idea behind forced real estate appreciation is to strategically raise a property’s net operating income (NOI). NOI is used to calculate property appreciation and measure the profitability of a home. The higher your NOI, the better the return on the initial cost of your investment, ie: purchase price. Raising your property’s NOI can be achieved in one of three ways:
The primary way investors force appreciation is by completing home renovations that increase property value. If you’re interested in home renovations with high ROI, discuss the following projects with a trusted real estate agent:
Keep in mind that forced appreciation doesn’t need to happen all at once. You can enhance curb appeal the first year, create a second bedroom the third year and finish remodeling your half bath in year five. There’s no specific timeline you need to follow when planning home renovations. Just make sure it's the right time in the market to make home improvements and that you have the necessary funds available.
Once you’ve enhanced your property value through home improvements, you’ll want to get your money’s worth, of course! The best way to do this in the short term is to increase your rental income by raising rents, minimizing vacancies, and implementing short- and mid-term rental strategies whenever possible.
Lastly, you can force appreciation by reducing monthly operating expenses. Investors should focus on reducing energy bills, managing water usage, and immediately repairing property damage. This helps conserve your property and ensure its functionality and safety throughout the years.
Calculating the average home appreciation rate on forced appreciation involves understanding your property’s NOI and cap rate.
NOI is easy to calculate. All you need to do is add up monthly revenues and subtract this dollar amount from monthly property expenses. Once you have your NOI, you can then use it to calculate your property's cap rate.
Cap rates are used to determine the rate of return on an investment property. You find it by dividing your property’s NOI by its current market value. Investors usually aim for a cap rate between 8% and 12%.
Once you’ve calculated these two figures you can then determine the forced average appreciation rate by dividing NOI by the cap rate.
As with any real estate investment strategy, forced appreciation comes with advantages and disadvantages. Although it’s a great way for investors to increase the appreciation value of property and home values in a relatively short amount of time, it’s not always possible depending on finances and local laws. Here are some factors to consider about forced appreciation:
Forced appreciation can be a great way to boost property value, but it’s not for everyone. It takes a considerable amount of planning to be successful. You also need to accurately calculate appreciation to secure a healthy ROI.
When considering whether or not forced appreciation makes sense for you, ask yourself if you have the time and resources available to implement one of the strategies mentioned above. If the answer is no, you could always try again at some point in the future.
You will also want to consider if the property you have or are looking to buy is fit for a forced appreciation. Make sure your property meets all of the following criteria before moving forward:
Successful investors may find a combination of both forced and natural appreciation methods maximizes returns. Ultimately, the key lies in making informed decisions, considering market conditions, and strategically implementing improvements to enhance property value and rental income. By staying informed and proactive, real estate investors can position themselves for success and navigate the dynamic world of home appreciation with confidence.