What is Price Appreciation (Real Estate Investments)?
Price appreciation in real estate refers to the increase in the value of a real estate property over a period of time. One of the goals of investing in real estate is to get a positive return on the investment when the investor decides to sell the property in the future.
The price appreciation of a property can depend on a variety of factors, such as the location, future development plans, the physical structure or the demand and supply of property in a given location. Property owners can also force appreciation of their properties by carrying out repairs and renovations on the property.
- Price appreciation is the increase in the value of a property over a period of time.
- The amount of price appreciation of a property is dependent on various factors such as demand and supply, interest rates, location, future development plans, etc.
- Some investors purchase properties with the goal of selling it later when the supply is low, in order to benefit from the price appreciation of the property.
What is Fair Market Value?
The fair market value of a property is the value that a property would fetch if it was to be sold in the real estate market. The fair market value of a property must meet the following conditions:
- The buyer or seller of the property must have the necessary knowledge of the real estate investment in order to make a reasonable decision.
- The investors are acting in their own interests and without any undue pressure from any party.
- The transaction takes place within a reasonable period of time to allow either of the parties to conduct due diligence and make informed decisions.
The conditions above must be met when determining the fair market value of a property. If any of the conditions are not met, then the value obtained does not represent an accurate valuation of the value of the property. Getting an accurate property valuation involves gathering statistical data from similar properties with comparable features.
The main method for determining the fair market value is known as comparative market analysis. The comparative method involves taking at least five real estate properties in the same location, and that are similar to the investment property being evaluated. It uses the market prices of the comparable properties or prices of properties that are currently listed for sale in order to arrive at the fair market value.
Factors that Determine Real Estate Appreciation
Real estate investors are always keen to purchase a property when they know that it will appreciate in value in a few years. It can become a source of financial security in the future. Price appreciation also provides the flexibility of selling the current property at a higher price than they originally paid, and then use the sale proceeds to purchase a bigger property to accommodate a larger family. The main factors that influence real estate property appreciation include:
1. Demand and supply
The forces of demand and supply also play out in the real estate industry. When the demand for homes is on the rise in a given geographical location, property prices in the area will also go up if the supply of new residential houses does not increase fast enough as the demand.
The increased demand for houses in a given location tends to attract the attention of investors who buy or build residential houses with the goal of putting them for sale when the supply declines and prices increase. End users would then be willing to pay more for a house that meets their preferences in order to beat other interested buyers. The extra gains that investors earn above what they originally paid for the house is the price appreciation of the property.
The location of a real estate property is a key factor that determines the price appreciation of a property. Property buyers are often looking for attractive and desirable locations that are near cities or markets, more prosperous economies, and better amenities and infrastructure.
Properties in such locations are often in higher demand because the majority of the population is looking to live an area that is accessible, close to the workplaces, and where properties are likely to fetch higher prices in the future. Owning real estate properties in such areas is likely to trigger real estate appreciation in the future. Buyers would be willing to pay more to own houses in an exact place within the neighborhood.
3. Property market drivers
Price appreciation of real estate investments can also be affected by any developments that exert a positive impact on the attractiveness and desirability of living in a given area. While the existing infrastructure can affect the property prices at the moment, you should watch out for any government and commercial plans for putting up new infrastructure in an area in the future.
Potential property drivers may comprise development of public transport facilities such as rail, road or airport; new office complexes; construction of a shopping mall or hypermarket; and proximity to schools, universities, hospitals, and restaurants, etc. Buying a property in an area with such future development plans guarantees property owners massive real estate appreciation in the future.
4. Cost of borrowing
The cost of borrowing at any particular time also directly affects the property market, as well as real estate appreciation. When the cost of borrowing is expensive, i.e., high interest rates, the demand for houses will decline because fewer people will be able to afford expensive loans.
Similarly, when the cost of borrowing is inexpensive, i.e. low interest rates, there will be a higher demand for residential properties because more buyers will be able to afford the cheaper loans. Also, when the Federal Reserve relaxes lending guidelines, a majority of potential buyers will qualify for credit facilities, which will increase the demand for residential houses and ultimately, raise the value of properties.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: