FORCED VS. NATURAL REAL ESTATE APPRECIATION
Real estate appreciation is far from being a new concept when it comes to real estate investing. Moreover, many real estate investors choose real estate for that very reason. The easiest way to describe the concept is by saying that it is the increase in the property value. So, in other words, that is the increase in the property price over time. However, there are two types that every real estate investor must know about: natural appreciation and forced appreciation. Even though both concepts share the same end goal (increasing the value of an investment property), they are different in other aspects. So, without any further introduction, let us get to the core of this subject.
Related: Cash Flow vs. Appreciation: What Should Drive Your Real Estate Investment Decision?
What is natural appreciation vs. forced appreciation in real estate investing?
Natural appreciation is a very simple concept. It is simply the rise in an investment property’s future value over time. So basically, you buy a rental property and hold on to it as long as you can and then sell it for more than what you’ve purchased it for. An important thing to note is that it’s called natural appreciation. This means that you have almost no control over it.
On the other hand, forced appreciation is when you take part in increasing the property’s present value. You could achieve this through many different methods. In fact, combining multiple methods sure does increase the property price. However, it is something you want to plan carefully in order to mitigate any losses. After all, your ultimate goal is making money in real estate investing and not losing it.
How to achieve natural appreciation vs. forced appreciation in real estate investing
I know we said before that you have no intervention with the natural appreciation process. However, there is a way you could achieve that in real estate investing. But first, let’s talk about the contributing factors that you have no say in.
In most cases, the real estate market is what determines whether investment properties experience an increase or a decrease in value. The two main reasons for natural appreciation would be 1) The rental demand is high while the supply for rental properties remains as is 2) The changes in the rates of interest and inflation have a direct impact on real estate investing. So, you see why we say you have no control over it as the real estate investor.
On the contrary, forced appreciation is something real estate investors can control. The increase in property price, in this case, is dependant on investors’ actions that contribute to the present value of the income property. One way to do it is by increasing the rental income. Of course, you can’t just come to your tenants and tell them “Hey, you are going to pay me $2000 instead of $1500 starting next month.” Instead, you can come up with strategies that help boost your rental income. You can add services, vending machines, have a pet policy that charges extra and so on. If you manage to do so, it will increase your net operating income. This means that it will increase your return on investment rate as well. Typically, an increase of $1 to the NOI means an increase of $8-10 to your property price.
How is natural appreciation connected to forced appreciation?
As we have stated before, you have no control over natural appreciation and only control forced appreciation. But, there is great news for you. Forced appreciation leads to natural appreciation but not the other way around.
If you manage to increase the rental income and therefore the return on investment of your income properties, guess what? Your property’s future value automatically increases. This means that you do have a say in natural appreciation as long as you manage to successfully force the appreciation of your real estate properties. However, before you get to that, you need to go through the analysis process which is our next topic.
The analysis process
There is no way for you to succeed in real estate investing without the analysis process. You see, buying an investment property is when the process of making money starts. Therefore, there are two types of analysis you should pay close attention to 1) The investment property analysis and 2) The comparative market analysis.
The investment property analysis is what deals with the return on investment. As the owner of real estate properties, you want to make sure that they have the potential for a high rate of return. This has a direct effect on both natural and forced appreciation as we explained earlier. The best real estate investments have higher rates of return that eventually lead to real estate appreciation in one form or another.
The comparative market analysis, on the other hand, is when you perform neighborhood analysis and compare your investment property to other similar ones within the same location. So, for the sake of selling an investment property at a higher price, you want to make sure that the location you pick promises high rates of appreciation. The only way to determine that potential is by looking at similar properties that have been sold within the last 6 months in that area. This is a great indicator of appreciation rates that a real estate investor can rely on.
Real estate investing strategies that complement natural and forced appreciation
The most common real estate investing strategy for natural appreciation is to buy and hold. Basically, it starts with buying property, holding on to it, and then selling the property for a higher price. Of course, rental properties go under the same strategy. As long as you are holding on to the property, you can rent it out and benefit in the short-run as well.
As for forced appreciation, fix-and-flip is the most common way to achieve that. Many real estate investors buy properties that are in a distressed situation for cheap. After that, they proceed with the renovation which automatically leads to forced appreciation. This increases the property value instantly and once they are done, they can sell it for more, covering the renovation cost in addition to making a profit.
If you are wondering how to buy properties for below market value, foreclosures and short-sales are your best options. These are typically sold in an “as is” condition and that is why they are cheap. You could start by finding the best real estate deals on listing websites.