Natural Appreciation

“An increase in the value of your real estate investment due to changes in the property market.”

When it comes to real estate the age-old adage of “Location, Location, Location” holds tremendous value for good reason. When a specific location (Market) grows in key performance indicators such as, job growth, wage growth and population growth the values of the property tend to follow similar growth.

Take for example Texas Instrument’s announcement of a 30 billion dollar investment (That’s right, Billion with a B) semiconductor wafer fabrication plant in Sherman, Texas that is predicted to create as many as 3,000 high paying jobs (Link above). With numbers like that there is little doubt that Sherman is going to see rapid growth in nearly every category to include rent growth and real estate value. Natural appreciation doesn’t sound too bad, huh?

The problem is you are relying on time and the overall local economy to grow to be able to capitalize on the profits (not in control) and growth on this level is hard to come by.

So are you saying that natural appreciation is bad?

Absolutely not! Location, Location, Location!

Location will always matter. To buy real estate in a market that doesn’t have strong key performance indicators will always be a bad move. To exceed a given markets growth rate you must force the appreciation.

Ok. Sound interesting but what does it really mean?

I’m glad you asked. I love forced appreciation and I have never been known for my patience. It allows real estate investors to rapidly increase the value of the property without having to “Wait it out”.

Forced Appreciation

“An increase in the value of the real estate investment property due to the investors actions.”

First off, not every rental property is a candidate for forced appreciation. That 150 unit just down the road from you built in 2010 is rarely a good candidate.

But why is that? It’s a great looking property!

Expectations for what an apartment should offer may change drastically from Beverly Hills to small town Iowa but within those individual markets the expectations are generally similar for a property. 2010 isn’t in the rear view so far as to no longer be considered “Modern” and was likely built with energy saving features.

Let’s talk about a few ways we force appreciation through "Value add".

1. Classic Units. Typically, this is an older property (1975-Early 2000’s) that doesn’t have interior upgrades like properties nearby. We’re talking about things like Formica counter tops, kitchen cabinets with no hardware, white appliances, and linoleum flooring. You will hear these referred to as classic units. Once upgraded they command a higher rent premium in line with the market.

2. Below market rent. “Market Rent” is essentially the going rate for an apartment based on characteristics such as interior features and square footage. Believe it or not, these do exist. Reasons they are below market vary, but often it is an owner that has held the property for a long time.

3. High vacancy = Opportunity. With apartments, 5% vacancy on average is typically a good thing. Unlike a single-family home, where you have 100% vacancy when your tenant moves out, with 100 units, 1 move out equals 1% vacancy. Healthy vacancy is necessary to make improvements in the units. It’s also one indicator that rent is priced appropriately. If apartments are in high demand in the market but the property has high vacancy, the potential exists for forced appreciation by identifying and correcting the problem. It could be as simple as a low marketing budget.

4. All Bills Paid. They are few and far between, but they do exist. These are apartments where the landlord is unnecessarily covering the cost of the utilities killing the bottom line. Implementing a simple administrative program called Ratio Utility Billing System (RUBS) allows the owner to charge back a large portion of the utility bill.

5. Excessive Energy Expenses. You know first-hand that swapping out a couple of incandescent bulbs saves you money because they last longer but also use significantly less energy. Now imagine how much could be saved if you replaced bulbs, toilets that were at 5-7 gallons per flush to 1.6 gallons per flush and low flow shower heads in 100 units. Even the smallest of changes can be incredible due economies of scale!

Now to get a better understanding of how forced appreciation increases the overall value of the property, we will need to go over what determines an apartments value later. (Hint: It’s not looking it up in Zillow)

Anticipate natural appreciation and control forced appreciation!

"Buying real estate is not only the best way, the quickest way, the safest way, but the only way to become wealthy." -Marshall Field