If you’ve been keeping up with the real estate market, you’ll know that home prices have been skyrocketing since the beginning of the pandemic. Recent data from the Federal Housing Finance Agency shows that nationwide median home prices were up 19.4% year-over-year as of February 2022. For most investors, that number is a sure sign to keep growing their portfolios.
With that in mind, if you’re wondering where that number came from, what’s causing the jump and how you can calculate the rate of appreciation on your property, keep reading. This post will tackle the question, “What is home appreciation in real estate?” Plus, it will explain how appreciation works and why it’s so essential to figuring out your profit margins as an investor.
What is home appreciation in real estate?
In real estate, home appreciation occurs when a home or investment property increases in value over a period of time. Typically, homeowners and real estate investors tend to think of appreciation when they’re ready to sell or rent.
In the homeowner’s case, an increased property value will lead them to earn a bigger profit once they’re ready to sell their property and buy a new home. The same is true for investors, except in their case, they’ll also have the ability to charge tenants a higher rent for the same investment property.
However, home appreciation also has an additional benefit that can be enjoyed while you own the property: added equity. Put simply, equity represents the portion of the property that you own outright. It’s the difference between what you owe on your mortgage, if you have one, and what the property is worth. Usually, homeowners and investors can leverage the equity that’s built up in the property to finance some of life’s biggest expenses.
How do properties appreciate?
Truthfully, real estate appreciation can be attributed to a variety of factors (we’ll discuss each of those factors in depth later on). At a high level, home appreciation rates can be attributed to broader economic factors like inflation, local housing market trends, seasonality, and even individual decisions, such as added home improvements or upgrades.
What is the difference between appreciation and depreciation?
That said, it’s also important to understand that homes don’t always appreciate. Sometimes they depreciate instead. Depreciation is the real estate term for when a property’s value goes down over a period of time. Like appreciation, it can be attributed to a variety of factors, such as an economic downturn, or even deferred home maintenance.
What factors affect home appreciation?
Now that you have a better understanding of the basics of real estate appreciation, the next step is to look at the specific factors that drive up home values. Here are a few you should know:
Interest rates
The Federal Reserve sets interest rates based on what’s happening in the economy. In downturns, when they want to encourage borrowers to stimulate the economy, they’ll lower rates in order to incentivize people to take out loans. Yet, when the economy is strong and they want to discourage the masses from borrowing or refinancing in such high numbers, they’ll raise mortgage rates again.
As you might be able to guess, low interest rates tend to raise home prices. Higher interest rates, on the other hand, tend to cause house prices to decline.
Supply and demand
First, supply and demand have an undeniable influence on price increases and affordability. When inventory is low, there aren’t enough available homes for the number of interested buyers. As a result, those buyers are forced to compete for the same, few available properties. In order to make their bids stand out from the crowd, they’ll often offer well over the list price. Eventually, this continued cycle drives up local market values and median sales price.
Location
Similarly, where a property is located typically plays a role in real estate appreciation. You don’t have to be that familiar with California or New York to know that San Francisco and New York City are two areas that experience higher-than-usual price growth.
As a rule of thumb, home buyers and renters alike tend to be drawn to walkable areas with lots of amenities and infrastructure. People tend to be willing to pay a premium to live in these areas and that tends to heighten the rate of appreciation. However, this rule doesn’t just apply to major cities. It holds true in nearly every locale.
Home improvements
Finally, the last factor that can bring about price changes in a property is the home’s condition. Most of the time, price increases can be brought about by making substantial improvements to the property, such as remodeling kitchens and bathrooms or adding square footage. Still, even smaller improvements, such as keeping up with a regular maintenance schedule, can impact home price appreciation.
What is the average home appreciation rate?
If you’re looking for average home appreciation rates, the Federal Housing Finance Agency (FHFA) is a go-to resource for home buyers and economists alike. The FHFA is home to the only freely-available, public collection of home price indexes for single-family homes. They track data on home sales going all the way back to the 1970’s.
As for where we currently stand, the home price index reveals that home appreciation rates have skyrocketed during the pandemic. According to the national data as of February 2022, median home prices are up 19,4% since last year.
However, keep in mind that the numbers will vary once you start to zero in on a particular location. For example, year-over-year, prices rose by 15.3% in the East North Central division, or the area that includes New York City. Meanwhile, it rose 20.3% in the Pacific division, which includes California real estate.
How to calculate home appreciation
While the Federal Housing Finance Agency is a great resource for market data, it won’t have information specific to our investment property. Fortunately, you can do a similar calculation from the comfort of your own home.
To calculate the rate of appreciation for your property, all you need to do is subtract the original value, or the total price paid to purchase the property from its current market value.
If you’re unsure of the current market value of a property, the best thing to do is to get an appraisal. That will give you the truest sense of its value in the current real estate market.
Beyond that, real estate agents can also provide you with an estimate of the value by completing a comparative market analysis. Plus, if all else fails, you can use sites like Zillow or Redfin to get an automated valuation, but be aware that those valuation models are not always the most accurate.
The magnifying effect of home appreciation in real estate investing
With all that said, it’s also crucial to remember that property value appreciation is often different from investment equity appreciation. Property value appreciation looks at the property’s current market value, much like the scenario described above. Investment equity appreciation, on the other hand, looks at how much money your particular investment in the property is worth.
Put simply, if you leverage your returns on the property, either by using a loan to make the purchase or by taking a fractional ownership stake, you can magnify the rate of appreciation for your investment. Let’s look at an example to see how this works.
For the purposes of this scenario, let’s say that you buy a $400,000 property and take out a loan for 50% of the purchase price, or $200,000. Here, your initial investment in the property is also $200,000 because you’d have to come up with that amount as a down payment to complete the transaction.
Then, over a period of time, let’s say that the market value of the property increases to 15% to $460,000. In that case, your investment equity appreciation calculation will look like this $460,000 – $200,000 = $260,000.
Those numbers represent a 30% increase in your equity investment compared to just a 15% increase in the overall property value.
Once again, though, bear in mind that those numbers can work both ways. Home appreciation rates can slow and depreciation can happen. Like any other investment, profits from the housing market are not guaranteed. Yet, even in economic downturns, real estate investors have the added benefit of knowing that they can still generate income by collecting from their renters.
Since the magnification effect of real estate debt is so strong, Arrived uses only a moderate amount of debt (55-70% of the purchase price) on our properties. Banks can be more aggressive in lending, and give buyers up to 85-95% loans on their properties. We believe that moderate debt is the right mix of upside potential while limiting downside exposure.
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Understanding real estate appreciation and how it works is crucial to any real estate investor’s success. After all, this method of calculation is a significant part of how you will determine your return on investment. To that end, use this post to help you get a handle on the basics.
Still, knowledge is just one hurdle when getting started with real estate investment.
While residential real estate has been the best long-run investment in modern history, operational headaches and larger upfront financial commitments prevent many people from participating. At Arrived, our mission is to empower the world to build wealth through modern real estate investing on their own terms.
Now, you can buy shares of properties, earn rental income, and build equity through home appreciation, and let us handle the rest. Browse through available properties to start investing hassle-free in real estate today.
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The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. The views reflected in the commentary are subject to change at any time without notice. View Arrived’s disclaimers.
