What Is Real Estate Appreciation?

All of the following information was taken from this site.

Real estate appreciation is a simple concept. It refers to how the value of an investment property increases with time. This kind of natural real estate appreciation is a great (and not to mention effortless) way of making money in real estate and getting a good return on investment when you decide to sell the investment property. On the other hand, a real estate investor can also consider forced real estate appreciation. This is when the value of an investment property increases once repairs or renovations are carried out. Looking at these two types, real estate appreciation depends on not only the state of the local market but also any repairs done on the rental property.

Fair market value

The fair market value of a rental property is the price that an investment property will sell for in the real estate market. The fair market value, by definition, depends on a few different factors:

Real estate market analysis

Basically, at least 5 real estate comps are found in the location of the investment property. These investment properties need to be as similar to the investment property in question as possible. Using their prices in the market, the fair market value is found.

How to Calculate Real Estate Appreciation?

Step 1: Future growth rate

\[Future \ growth=(1+annual \ rate)^{Years}\]

The first step involves calculating future growth in the value of real estate by figuring out the annual rate. This is where you will have to do a little extra research. The annual rate of the real estate appreciation growth is easily available for the national market. The US house price index reveals that house prices have increased by 3.4% a year (since 1991). This is what we’ll be using for the sake of our example.

For the years, consider how many years you plan on holding onto the investment property. With this, you will have the future growth rate of value.

Step 2: Multiply future growth by current fair market value

\[Future \ Value = (Future \ Growth) * (Current \ Fair \ Market \ Value)\] Once you have the future growth, multiply it by the current fair market value from the real estate market analysis to see the future value of a real estate investment property

Forced Real Estate Appreciation

As mentioned, there are two kinds of real estate appreciation: the one that occurs naturally over time; and the other which depends on repairs done on the investment property. For this, you will have to find the after-repair value. This is simply done with real estate market analysis. Look for real estate comps that have similar accommodations that you plan on adding in renovation and find out the fair market value which will be the after-repair value.

Example calculation

get_appreciation <- function(annual_rate, years, recently_sold_comps) {
  if (length(recently_sold_comps) == 1) {
    current_fair_market <- recently_sold_comps  
  } else {
    current_fair_market <- mean(recently_sold_comps)
  }
  
  future_growth <- (1 + annual_rate/100)^years %>% round(2)
  future_val <- (future_growth * current_fair_market) %>% as.integer() 
  future_val / 1000
}
# inputs
nat_annual_rate <- 3.4
comps <- rnorm(n = 5, mean = 200000, sd = 15000) %>% as.integer() 
years <- 10

# model
paste0("Future home value is: $",
       get_appreciation(nat_annual_rate, years, comps) * 1000
       ) 
## [1] "Future home value is: $283544"

Plot appreciation curve over time assuming diffrent growth rates.

pess_growth <- 1.5
nat_avg_growth <- 3.4
optim_growth <- 5
comps <- rnorm(n = 5, mean = 200000, sd = 15000) %>% as.integer() 

d <- list(growth_rate = c(pess_growth, nat_avg_growth, optim_growth), 
          years = 1:20) %>% 
  expand.grid()

d %<>% 
  mutate(future_value = get_appreciation(growth_rate, years, comps),
         growth_rate_fact = as_factor(growth_rate %>% as.character()))

# now plot
ggplot(aes(x = years, y = future_value, color = growth_rate_fact,
           group = growth_rate_fact), 
       data = d) + 
  geom_point() + 
  geom_line(size = 1) +
  ggtitle(label = "Home Appreciation", subtitle = "(assuming different annual growth rates)") +
  scale_color_manual(values = c("grey40", "darkblue", "grey40")) + 
  labs(y = "Future Home Value (thousands)", x = "Years Owned") +
  guides(color = F) +
  lims(x = c(0, max(d$years) + 3),
    y = c(min(d$future_value - 100), max(d$future_value) + 100)) +
  directlabels::geom_dl(aes(label = growth_rate_fact), 
                        method = "last.polygons")