What is Real Estate Appreciation?
Real estate appreciation is the simple concept of your home or investment property being worth more each year. Just as other items get more expensive over time (thanks to inflation) so do homes.
Real Estate appreciation is one of the four ways investors make money with real estate alongside cash flow, mortgage pay down and depreciation. Calculating these 4 things can help answer the question, is real estate a good investment? That being said there are two different ways to benefit from home appreciation.
Forced appreciation is when you invest time and money into making improvement on the home. This could include new flooring, new paint, replacing light fixtures and so much more.
The idea here is that you can put $1 into the home and expect $3 or more back in appreciation. Example being, a $5,000 kitchen remodel should hopefully increase the homes value by $15,000.
Not all improvements are equal so you must do your research. An expensive new HVAC system or foundation repair might be important but it isn’t going to increase your home value like refinished cabinets and a new bathroom.
Natural appreciation is pretty self explanatory. It’s when your home increases in value by a small percentage each year that you get to profit from by simply owning the property.
Though natural appreciation can hover around 3% annually, 3% appreciation on a $300,000 home is still $9,000 you get from doing almost nothing.
Average Real Estate Appreciation
Average real estate appreciation is kind of a moving target and depends heavily on your location, home type and population growth. However, the 25 year average for home appreciation is around 3.8%. Just remember this is an estimate so when you are doing a spreadsheet for a rental property include on using the average appreciation rate and one with a lower percentage.
Federal Housing Finance Agency Calculator might help with your estimate.
If the lower appreciation example still shows sign of a good investment than great. If by the end of the year you do in fact get 3.8% or higher than that’s juts an added bonus. That being said, never rely on appreciation to save the deal.
How to Calculate Real Estate Appreciation
Here is a great rundown and easy to use formula from Mashvisor for calculating your real estate’s new value after appreciation for however many years you’d like.
Future Growth= (1 + Annual Rate)^Years
The first step involves calculating future growth in the value of real estate by figuring out the annual rate. This is where you will have to do a little extra research. The annual rate of the real estate appreciation growth is easily available for the national market. The US house price index reveals that house prices have increased by 3.4% a year (since 1991). This is what we’ll be using for the sake of our example.
To the national annual rate (0.034), add 1. For the years, consider how many years you plan on holding onto the investment property. With this, you will have the future growth rate of value.
Future Value= (Future Growth) x (Current Fair Market Value)
Once you have the future growth, multiply it by the current fair market value from the real estate market analysis to see the future value of a real estate investment property
Comparative market analysis returned a fair market value of $150,000 on a potential investment property. A real estate investor plans to hold onto the rental property for 5 years before selling. Let’s see how much the future value of real estate will be thanks to appreciation:
Future Growth = (1 + 0.034)^5
Future Growth = 1.18
Future Value = (1.18) x (150,000)
Future Value = $177,000
In five years, the investment property will be worth approximately $177,000.
*If you’re interested in starting real estate investing but have little capital to work with, I have a guide on how to invest in real estate with no money and bad credit.
Live Example: Real Estate Investing Spreadsheet
Here’s a great example of a duplex I found that I was going to owner occupy. Owner Occupying means you get a normal 30 year fixed rate mortgage and live in one of the units while still renting out the other. This is great for people getting started in real estate investing. If you don’t have any capital to get started you might want to consider investing in real estate with no money, it even works if you have bed credit as well.
Here is the fair market value for the home. You can see the purchase price, down payment, and the loan terms.
Here is the rental income. Unit A rents for $750 and unit B rents for $625 but since I would be owner occupying, I would live in that unit and therefore collect no rent from it.
Here are all the expenses including property taxes, insurance, PMI and a maintenance reserve for any unexpected repairs.
After calculating all my expenses the monthly cash flow comes out to be -$103.25. Why is this good? Well for the same down payment I could’ve used to buy a single family property I now could own a duplex, rent one unit out and live there for only $103 a month. Not too shabby for my first year.
*This means next year, when I would’ve moved out and rented both units I’d have a cash flow somewhere around $500/mo.
Now comes down to the 3 main ways to make money with real estate. And now you’ll see why cashflow isn’t everything. Thanks to my tenant living there he paid $1,578 of my mortgage principal that year.
Thanks to leverage and being able to own a property with only a 15% down payment, I got to benefit from the sweet 3% appreciation, not on my investment but the VALUE of the home which is $130,000. This means by owning the place I made $3,660 in appreciation. And even with the -$1,239 in cash flow that year I made $3,999 on my $21,300 investment which is a 18.77% ROI. (And I lived for almost free)
Oh.. and if I purchases the duplex as an investment and didn’t owner occupy.. here are the numbers. $10,822 return on a $21,300 investment equaling a 50.81% ROI. Basically doubling my money every 2 years!
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