Appreciation, or increase in the value of your real estate investment, is the biggest and most exciting way to create long-term wealth.
In fact, increase in the value of real estate is the number one way that millionaires are made in real estate.
It occurs in two ways:
- Market Appreciation
- Forced Appreciation
Market Appreciation: This is the appreciation of your real estate over time. You might have experienced this in the past when the prices of homes in your neighborhood start increasing. In most cases, this is the result of the overall market going up. Think of this as riding a wave up (or down).
In the multifamily sector, market increases occur with increases in population, jobs and demand vs. supply. Essentially, natural market appreciation will occur where there are more renters with jobs opting to rent.
As covered in my earlier post on choosing the right market to invest in, market appreciation tends to occur rapidly in coastal markets. This is in comparison to the markets in the Midwest where there is a more gradual rise and fall.
This is why selecting the right market and location for your investment is critical.
By having the right asset type, in the right market, that matches your goals, you are more likely to increase your wealth. One of the best ways to predict when a market is going to appreciate is by analyzing market cycles.
However, investing in cyclical coastal markets is not always the right answer. Depending on your goals and risk tolerance, investing in more linear markets can offer many advantages with less downside risk.
Forced Appreciation: This is the secret sauce for creating long-term real estate wealth. It is the increase in value through actions taken by the owners. This occurs when the investors can force an increase in net operating income (NOI) by increasing revenue, decreasing expenses or both. For instance, adding amenities, capital improvements and steadily raising rents all increase NOI. By increasing the NOI, the value of the property is “forced” to increase exponentially.
To force increase in value, it is critical to have the right team. Professional property management and picking assets with value-add components in a growing market with favorable demographics is the key to unlocking long-term wealth. The better a property is operated, the more money the investor will earn while owning it and the more the property will be worth.
If the property is improved just a little bit each year, the underlying increase in property value is exponential. Small changes make a big difference!
Let’s walk through an example:
In a 100-unit building with a 6% cap rate, if rents are raised by just $25 per month per apartment, the value of the property increases by $500,000 or half a million dollars. If we steadily raised rents by $25 per month over a 4-year period, we have increased the value of the property by $2 million!
Properly done, this increase in real estate value offers increases in cash flow and tax advantages. You don’t have to be a speculator to take advantage of this.
In fact, “forced” appreciation truly is the secret sauce and the number one way that millionaires are made in real estate.