What Is Forced Appreciation? Here’s the Good, the Bad, and Everything Else
There is a phrase in the real estate investing world that says, “We buy for cash flow.” What this means is that when we analyze a property to purchase as a rental, we typically buy it because of its ability to cash flow. However, some investors will buy properties for appreciation, meaning they believe the value of the asset will go up over time. Your investment goals are obviously up to you, but think about this … If you buy a property just because you think it’s going to appreciate and you disregard the cash flow numbers, what happens if the property goes down in value? You’d then have a non-performing asset with negative cash flow. Not good...
Sometimes, what investors will do is force the appreciation of the property. Forced appreciation happens when you control the value of your investment property. You can do this by decreasing your operating expenses, by increasing your income or by reconfiguring or rehabbing properties in a specific area that sell at a higher value than you bought it for. The latter is usually analyzed and decided upon prior to purchasing the property.
While forced appreciation is done by the owner of the property controlling the value, natural appreciation is completely dependent upon the real estate market. This happens through supply and demand, inflation, mortgage interest rates, and the economy.
Hoping for natural appreciation isn’t much of a game plan and if you purchase a property solely because you think it may appreciate, that’s risky. There are market indicators that can help you make an educated assumption as to what will happen with your investment, but even then, nothing is certain. With forced appreciation, you have many more benefits with your property. For one, if the value of your income goes up by increasing the property’s rent, this would mean greater cash flow. With greater cash flow comes greater investment analysis. If you put more of that cashflow toward the principal, ideally, you would gain more equity.
Equity is another benefit because if you understand what you can do with it, like borrow against it or leverage it, it can provide you with an opportunity to purchase more properties. Leveraging the equity into another investment is a key mindset as an investor where your money is a tool. A third advantage is the timeframe. Your property can appreciate quickly with forced appreciation verses waiting for it to appreciate naturally over time. If you time everything right, you may be able to resell your property at the top of the market and get a larger sum of earned income to reinvest.
When we invest, we always want to cover our bases, make sure we have multiple exit strategies and verify that we understand the different options and what types of returns they will provide. Through educating yourself financially and by having a support system or mentors to help you along the way, rest assured, you will be in a much better position when it comes to finding deals and executing them for profit. Cash flow, forced appreciation, rental arbitrage, they all sound nice, but if you do not understand the basics of investing, you may never get an opportunity to maximize what you can do with your real estate investments. Legacy’s Building Wealth Club is a great way to educate yourself so you can take advantage of building wealth in real estate. We’d love to help you keep the momentum going on your journey towards becoming a real estate investor.
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