One of the many benefits of investing in any real estate opportunity is capitalizing on the property’s expected appreciation. Appreciation, or the increase in the value of your real estate investment, is the biggest and most exciting way to create long-term wealth. Appreciation can occur in various ways. Two of the main ways a multifamily commercial property can appreciate are:
1. Market Appreciation
2. Forced Appreciation
By now, most of us know about Market Appreciation: This is the appreciation of your real estate property over time. You might have experienced this in the past when the prices of homes in your neighborhood have increased. In most cases, this is the result of the overall market going up. A rising tide that lifts all of the boats! What you may not be familiar with is the concept of Forced Appreciation.
What is Forced Appreciation?
In the multifamily space (or apartment investing), Forced Appreciation is the secret ingredient that makes investing in apartment buildings so delicious! It is the increase in value through actions taken by the rental property owners. This occurs when we can force an increase in net operating income (NOI) by increasing revenue, decreasing expenses or both. Adding amenities, facilities and services along with 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 an increase in value, it is critical to have the right team. Choosing the right property management team and picking assets with value-add opportunities in a growing market with favorable demographics are all keys to unlocking the most favorable valuation for any commercial real estate asset. The better a property is operated, the more money the investors will earn while owning it and the more the property will be worth.
There is no better way to immediately add value to a commercial real estate project than to make a force appreciation happen and unlock that additional value. If the property is improved just a little bit each year, the underlying increase in property value is exponential. Small changes definitely make a big difference!
Let’s look at an example:
Let’s say we have a 100 unit building in a city that supports a 6% cap rate. If rents are raised by just $25 per month on each apartment, the value of the property increases by a half of a million dollars. If rents are steadily raised by $25 per month over a 4-year period, we have increased the value of the property by $2 million!
As you can see, with a slight increase in rental income, our property has appreciated by $500,000 in a matter of one year. So, imagine the amount of property appreciation if you cut down on property expenses and added a few extra services!
In the video below, our founder, Rob Overstreet takes a minute to talk about Forced Appreciation and how our investing partners benefit from it.
Properly done, this increase in real estate value can offer increases in cash flow and additional tax advantages. You don’t have to be a market speculator to profit from this. In fact, “forced” appreciation truly is the secret sauce and the number one way that millions are made in commercial real estate investment.