This is number six in our series on building a real estate investment business plan.
Appreciation is the increase in the value of your property over time from when you purchase the property until you sell it. Economic factors control whether a property goes up or down. Unfortunately, real estate investors have no control over economic factors. So it is a mistake to think about buying a property solely for the appreciation factor.
However, you can buy a property at or below market value and fix it up to market standards or above to increase the value of the property. Since this forced appreciation is something you do have considerable control over, looking for a property that is undervalued makes sense because you know that you have a built in equity and appreciation after you purchase and rehab it.
Building property values
You know can increase the value of your property by making improvements that are cost effective and give you a higher rate of return like updating kitchens and baths, adding a new roof, replacing flooring, painting and landscaping. Try not to make too improvements that are too costly because you won’t be able to recoup what you spent when you go to sell the property. The smaller less costly improvements tend you pay off better. In a seller’s market when there is less inventory and high demand, prices appreciate. When there is a too much inventory and it is considered a buyer’s market, prices go down. Real estate goes in cycles.
Demand influenced by economic conditions such as employment, types of jobs, interest rates, availability of land, and proximity to transportation, public services, shopping, restaurants entertainment, population growth, desirability, crime and property tax rates is cyclical. Unfortunately, investors and buyers have no control over economic factors, but there are indicators when interest rates change, unemployment rates go up or inflation occurs. Savvy investors keep an eye on economic conditions when there are indications that there may be change one way or the other. For instance, the past few years, investors have been investing in distressed properties because there has been a huge influx of foreclosures and short sales constantly flooding the market.
So if you purchase a distressed property at or below market value at least 20% to 60% below the retail price, if the property appreciates, you have a nice big property when you go to sell it. For instance in our example above, the distressed property you purchased for $200,000, rehabbed for $10,000 and then sold for $250,000, gives you a nice profit on the appreciated value of your upgrades that only cost $10,000.
Property values and price fluctuations
However, let’s say you keep the property five years, but the value keeps going down due to economic factors, so you rent it out during that five year time. You find that the property is now worth less than you paid. You would still get the benefits of property ownership and the positive cash flow even if the property depreciated. If you keep it for another five years, the market values may appreciate back up to what you paid for it or a little higher.
As long as you are getting a positive cash flow, you are still benefitting from owning the property. Unless you are experiencing a financial hardship, you probably don’t need to sell the property and can hold on to it until property appreciates again.