Appreciation, We Love It but Don’t Rely On It
Real estate appreciation is the stock market function of the real estate investing game. Just as stocks are held for capital gain, the same goes for real estate when held in the same manner. It’s the yang to depreciation’s yin–opposite in nature, but powerfully complementary and another benefit you can capitalize on.
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The concept of real estate appreciation has certainly gotten a bad rap in our post-2008 housing meltdown society. Many feel that property simply does not appreciate anymore after the crash. Leaving the calculation out entirely is more conservative, but don’t go through the roof quite yet on that recommendation. Since we’ve discussed three other benefits of real estate investing, you know by now that we could still build wealth even if we ignored appreciation in our profitability calculations. Cash flow for buy-and-hold investments and improving below market assets “fix and flip-style” are what you should primarily focus on when evaluating deals.
Appreciation Return on Investment Example
Here’s an example of how much a $100,000 property could be worth in 30 years, including the Return on Investment (ROI) you could get on the property:
$100,000 Purchase Price at 3.7% Appreciation = $297,414 after 30 years
(Hint: Use this Home Appreciation Calculator to come up with this value.)
To get your ROI, you’ll want to consider how much cash you invested into the property. Given a 20% down payment and $3,000 for closing costs:
Total Cash Invested = $23,000
After 30 years, your mortgage will be paid off, which means the entire $297,414 after 30 years is yours in Equity! One more thing we need to do in our calculation is to figure out our cash flow and add that to our total revenue from this property. We’ll do the difficult part of the calculation for you and assume your rent is $1200/month and that you end up with $300 in Cash Flow every month. Given a 3% yearly rent increase to compensate for inflation, your total Cash on Cash Return (CCR) after 30 years is…(drum roll please)
30 Year CCR = $110,617
We threw in the cash flow example to show you how powerful real estate is. We cover this further on our blog and video for the “I” in IDEAL Investing: Income.
Okay, so let’s take our Equity after 30 years, assuming we are selling it outright ($297,414) and then our CCR ($110,617) and do a cumulative ROI calculation. This sounds confusing, but all we are doing is just totaling the total return on investment over the entire 30 year period. We’ll divide that by 30 right after to get your total yearly ROI:
Cumulative ROI = ($297,414 + $110,617 – $23,000) / $23,000
Cumulative ROI = 1674% (Woah! Let’s get a yearly ROI to bring us back to Earth)
Yearly ROI = 1674% / 30 = 55.8% ROI per Year
Yearly ROI due to Appreciation only = ($297,414 – $23,000) / $23,000
Yearly ROI (Appreciation after 30 Years) = 39.77%
The Power of Real Estate Appreciation
So, there you have it. A 3.7% increase in Appreciation doesn’t sound like a whole lot, but the power of compounding your investment cannot be denied, and remember that the tenant is paying your mortgage for you in this example. Sure we had a housing meltdown in 2008 and the last 10 years don’t look too good according to the appreciation site we mentioned above, but if the entire 50 states are cumulatively green since 1975 and the past 5 years look pretty darn good too. Remember that real estate investing is a long-term investment and although you are fighting inflation, if you bought for positive cash flow, you are increasing your rent to make up for inflation and the other pieces of an IDEAL Investment, such as Depreciation and Leverage, are also there to help you.
How to Know if Your Property is Appreciating
How do I determine what my house is worth to know if it appreciated? If you really need an accurate estimate, the best way is to have your property professionally appraised. If you don’t wish to go that route on every potential property you see, use other properties in the area, i.e. comparables, to get a quick assessment on how values are increasing/decreasing over time. HomePriceGraph.com has an appreciation calculator and graph that lets you compare the real estate appreciation in your city vs. other cities or the entire USA.
One good way use comparables is to do a Comparative Market Assessment (CMA). Check our blog here for more details. Another method is to take the average of popular online estimates from sites such as Zillow, Realtor.com, and Redfin. Add the tax assessed value from the county assessor’s site as another sanity check. These methods are not exact of course, but it could get you with 10% of the real value.
As you know by now, you already have Income, Depreciation, and Equity on your side when you invest in real estate. Make sure you also value, treasure, and admire the benefits of real estate appreciation and watch your investment property roar and your net worth soar!
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Before you leave:Don't forget to check out our free rental property calculator. This will be a valuable tool in your arsenal as you analyze your existing or potential rental properties.
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