Is real estate appreciation the only way to gain value?
Value gains, which can determine the pricing of real estate or the amount of money you can make in real estate comes from three areas 1) appreciation 2) inflation and 3) actively creating value. People don’t tend to recognize the difference in every day discussions on the topic of value in property and what effects pricing. I’ll explain them here very briefly:
1) Appreciation is all about supply and demand and happens when demand for particular property type and/or a certain location grows faster than supply.
2) Inflation on the other hand pushes up the prices of property even if supply and demand are stable.
3) Actively creating value is where the smart investor can extract value from a piece of real estate by employing value add strategies like renovations, subdivisions or increased cashflow for faster amortization etc. I won’t attempt to list them all here as there are many ways to actively create value which deserves its own article.
This applies to all real estate. For example, let’s consider a piece of commercial real estate like a parking lot structure in the heart of Manhattan. The supply for this particular type of real estate is very low and demand for parking is very high and there are minimal substitute structures to accommodate the demand. This in-turn drives up value and subsequent price gains. However, the same like-for-like parking lot structure outside Manhattan, let’s say it’s located at a train station on the outskirts of the city, will see less appreciation as demand for parking is likely to be lower.
But the question here is, do you need appreciation to gain value? Inflation has a significant impact here too. In simple terms, as the banks print more money the purchasing power of a currency is reduced, and property prices are pushed up which can give you a false sense of security when assessing your property price gains. However, the reality is that if you couple appreciation with inflation and you actively create value you will be able to outperform average inflation and price increases of real estate. An example of this would be from rental income which gives you amortization meaning your income is effectively paying down the debt on a given property giving you more equity in a property which may not have appreciated very much.
Let’s go back to that example of the parking lot on the outskirts of the city next to a train station; it will see less appreciation due to supply and demand but may still see a lot of cash-flow from commuters. A simple example to illustrate this would be if you had put a $100,000 as a down payment and over the course of 5 years you were able to pay down the mortgage and grow your equity ownership to $1,000,000. In this case you would gain value in the amount of equity you now retain and will also have benefited from passive income along the way. With cash-flow working in tandem with inflation you are also able to essentially outperform inflation using this method. Equally, the same value gains can be had if you also look for real estate which is below market value with the intention of a purchase, rehab and resale strategy in which you can benefit from the same 5 years of amortization-like or appreciation-like price gains at the point of purchase and again, outperforming inflation.
Historically real estate has proven to stand the test of time because price gains on a given piece of real estate are still attained even with inflation competing with appreciation. What I’m hoping you have gained from this article is that you do not need to be solely looking for real estate in areas you hope will appreciate in value as there are other ways to achieve the same results, if not better in a shorter time frame.