As we saw in our article on appreciation in real estate, appreciation is simply the value growth of an investment over time. Real estate is an appreciable asset because of its natural scarcity. Property values may dip temporarily due to short-term market conditions, but they will always rise over the long term.
Forced appreciation is when an investor actively adds value to an asset rather than waiting for the asset to appreciate as the general market grows in value.
In this article, we’re doing a deep dive on forced appreciation:
- How it works,
- The benefits it offers, and
- Specific strategies you can use to force appreciation in your real estate investments.
Forced Appreciation: The Details
You can force appreciation in real estate in two different ways:
- Increasing the property value, and/or
- Increasing rental rates.
We’ll provide specific strategies for forcing appreciation later in this article, but for now, let’s look at a common example of each.
Forced Appreciation Through Adding Value to the Property
Renovating a property is a classic method of adding value to real estate, thereby forcing appreciation. We often see this in home flips. The investor will purchase a property, rehab the structure (perhaps enhancing the lot as well with landscaping or hardscaping), then sell the property. When done correctly, the sales price far exceeds the purchase price of the property plus the costs of labor and materials for the renovation project, giving the investor a tidy profit.
For a real-world example of adding value to forced appreciation, consider this recent house flip in Los Angeles. This single-family home on 9th Avenue in Los Angeles was purchased for $500,000. After an extensive 13-month renovation project, the property sold for $1,100,000! After all construction expenses, closing costs, and project management fees, investors earned an impressive return on investment (ROI) of 19.05% on the deal.
Forced Appreciation Through Increased Rental Rates
Of course, you could increase rental rates by adding value to the property. But there are also ways to increase rental rates, whereby forcing appreciation without directly adding value to the property (although, the increased rental rates will make the property more valuable).
That sounds complicated, but an example will help.
In our article on increasing rental property value, we saw that simply practicing good property management can lead to increased rental rates.
You can charge more in monthly rent if you:
- Have a comprehensive marketing plan that generates interest in your units,
- Screen prospective renters to find those who are most likely to be reliable tenants,
- Offer just-below-market renewal rates to incentivize long-term residents to stay and reduce turnover expenses,
- Respond promptly to maintenance requests to show your commitment to your residents, and
- Go pet-friendly, which appeals to a wide range of renters, while potentially boosting income through “pet rent” (in states where this is allowed).
As you can see, good property management can increase your rental rates without requiring any capital improvements to the property itself. And, because the values for multi-family properties are based on rental income, increasing the rental rates increases the property value!
Benefits of Forced Appreciation
There are multiple advantages of forced appreciation, including:
- Forcing appreciation increases your equity in the asset. And you can potentially borrow against this equity (once a formal real estate appraisal confirms the higher value) to grow your portfolio faster.
- Forced appreciation can also increase your cash flow potential. For example, if you renovate a rental unit, you improve the property value and you can charge higher rent for that unit. Learn more by reading Cash Flow vs. Appreciation.
- You might have less competition from other real estate investors if your properties offer more value to renters than similar properties on the market.
- Forcing appreciation grows your net worth faster than waiting for general market forces to push property values higher.
Risks and Considerations of Forced Appreciation
There are a couple of factors to consider before deciding if forced appreciation is a solid strategy for your investment portfolio:
- Many properties don’t have much room for forced appreciation. New construction and newly renovated projects, for example, may not offer enough transformational potential to be candidates for adding value.
- Evaluating forced appreciation opportunities required additional time and analysis.
Strategies for Achieving Forced Appreciation
We’ve already seen examples in this article of how you can force appreciation through renovations and good property management. Now, let’s look at more strategies you can use to force appreciation in your real estate deals.
Strategy #1: “House Hack”
House hacking simply means to generate income from your primary residence. There are many ways to house hack, including renting out spare bedrooms and storage spaces. This rental income forces appreciation through recurring cash flows.
Strategy #2: Add an ADU
ADUs (Accessory Dwelling Units) have become an extremely popular way to force appreciation, particularly in markets that streamline the permitting processes for these structures (like California, for example). An ADU could be a separate building on the same lot as the main house, such as a guest house or casita. Or you could convert a basement, attic, or garage into an ADU, like a guest suite or in-law quarters.
The point of an ADU is to create two independent living spaces on one property. This increases the property value by adding more usable square footage. And it can simultaneously create a rental income stream if you choose to rent out that second unit.
Strategy #3: Add High-Demand, Low-Maintenance Amenities
Adding amenities is a way to add value to a property without necessarily renovating. Amenities can increase your rental income and boost the resale value of the property. However, to keep operating expenses low, you should opt for amenities that won’t require a lot of ongoing maintenance. High-demand, low-maintenance amenities include parking, in-unit washer/dryers, and rooftop decks.
Strategy #4: Consider Converting Your Long-Term Rental into a Short-Term Vacation Rental
Short-term vacation rentals typically command higher nightly rental rates than long-term rentals. So, converting your long-term rental into a vacation rental could potentially increase your rental rates and force appreciation for the property. You will want to complete a detailed analysis before making the switch as short-term rentals are susceptible to local legislation, hyper-local demand factors, higher maintenance, and greater wear-and-tear.
Strategy #5: Go Green
Making your property more eco-friendly could increase its value (and increase monthly income if the property is a rental). Buyers and renters alike are willing to pay more for a home that is eco-friendly both because they value the commitment to the environment and because they know that “green” upgrades could save them money on their monthly utility bills. Energy-efficient appliances, solar panels, and ENERGY STAR® windows are all strong candidates for your green initiative.
Key Take Aways
- Forced appreciation in real estate is when a property owner manually increases a property’s worth rather than waiting for general real estate market conditions to raise the value over time.
- You can force appreciation by either adding value (through a renovation, for example) or increasing rental rates (through strong property management practices, for example).
- There are several specific strategies a real estate investor can use to quickly force appreciation, including building an ADU, adding amenities, or converting a long-term rental into a short-term vacation rental.
Gatsby Investment is an investment company that specializes in real estate syndication, making unique deals available to everyday investors.