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What is Forced Appreciation?

forced appreciation

Summary: Did you know that there are three types of appreciation that affect the value of rental properties? Do you know which of the three will set you free? Hint: forced appreciation. In this post, we cover the three types of appreciation, with a special focus on forced appreciation. The goal is to help you understand the importance of each type and show you how to use force appreciation to grow your wealth.

When most people think about appreciation, they think about their property increasing in value over time. The assumption is that the value of your property will go up as property values in the neighborhood go up.

This is called market appreciation. But did you know that there are actually two other types of appreciation besides market appreciation?

In this post, we cover the three types of appreciation and explain why forced appreciation is the one that will set you free. 

 

The three types of appreciation 

There are three types of appreciation in real estate: market appreciation, immediate appreciation, and forced appreciation. 

Market appreciation

Market appreciation is the increase in value that occurs across a given market. 

It’s something you can’t control. It goes up or down or stays the same whether you like it or not. You may be able to predict it to some extent by having insight into the path of progress of a particular neighborhood or the demographics of a particular city or region. However, you have no control over whether your property actually gains value.

Betting on market appreciation is a risky venture. But that’s a story for another day. Or you can go read about Kenji’s experience if you want to get a taste of what can happen when you bet on market appreciation. 

Immediate appreciation

The second type of appreciation is immediate appreciation. 

You get immediate appreciation if you buy a property at a discount. In other words, if a buyer would pay more for a property and you are able to buy it for less, you’ve got immediate appreciation. 

Some people call this “buying it right.”

There are two main ways to achieve immediate appreciation.

The first is to offer less than the property is worth. Why would a seller agree to an up-front discount? Sometimes properties sit on the market for a variety of reasons. A seller would entertain a lower offer when their property doesn’t generate the level of interest they had hoped it would receive. Another reason is if the seller needs to sell the property quickly. They will accept a lower offer in this situation because price isn’t the most important consideration for them. One other reason is when agents get the market price wrong and list it lower than it’s worth.

You might think that the above doesn’t occur very often in a hot market, but most of our properties fall into one or multiple of the above categories. For example, we bought one four-plex that was listed under-market by the listing agent. We put in an offer immediately and the seller accepted. Soon after our offer, he got calls from other agents telling him that their client would have offered $40,000 more!

The second way to achieve immediate appreciation is through negotiations. Most people assume that you can’t negotiate a discount, especially in a hot market. We have also had students in our courses “feel bad” about negotiating. The truth of the matter is, you can negotiate a discount in the majority of cases. You just have to know how!

This is something we cover extensively in our Zero to Freedom real estate course. We’ve had former students tell us that they easily paid for the cost of the course from their first negotiation! One student even negotiated a $200,000 discount, lowering the purchase price from $970,000 to $770,000. That pays for a few courses and then some!

Forced appreciation

Forced appreciation is when you, the investor, control the increase in value of a property. 

How can you increase the value of a property? 

You increase the value by increasing the money that your property generates, or the net operating income (NOI). 

You increase NOI by increasing income or decreasing expenses. 

Ways to increase income include increasing rents, finding sources of additional income such as storage units, coin-operated laundry, pet rent, charging for parking spaces, etc. 

On the other hand, ways to decrease expenses include billing back utilities, lowering maintenance costs, etc.

Forced appreciation is a huge driver of wealth creation. This is because often the amount you spend to grow your net operating income is usually much less than the appreciation of the property. So for example, you can spend $15,000 on improvements and increase the value of the property by $40,000.

 

How to calculate forced appreciation

Forced appreciation = Net Operating Income / Capitalization (CAP) Rate

As I mentioned above, the net operating income (NOI) is based on a property’s income and expenses, excluding the mortgage costs. It’s simply revenue – operating expenses. 

Which brings up the next natural question: What is a CAP rate?

Mathematically the CAP rate = NOI / Current Market Value. 

CAP rates are established by sales prices of properties in a particular area relative to the amount of income these properties generate. 

For example, if you have a city like Seattle where people are willing to buy properties that don’t cashflow well, you have properties selling at a low CAP rate like 3%. 

If you’re in a less desirable area or an area where investors are seeking cashflow (and not gambling on market appreciation), you can often find properties for sale with CAP rates of 6-8%. 

If you want to know the CAP rates where you’re investing, the easiest way to figure this out is to ask your investor real estate agent.

An example of a forced appreciation calculation

Let’s use one of our duplexes as an example for calculating forced appreciation.

In 2015, Kenji and I bought a duplex for $176,000 with total rents of $1600 a month. Over the course of two years, we ended up putting in an additional $45,000 in rehab and tapping sources of hidden value (such as renting a garage and charging back utilities to the renters) to increase our rents up to $2,500 and at the same time, we’re billing utilities of about $200. 

The combination of higher rents and lower expenses drives up NOI significantly.

Not surprisingly, our property has significant forced appreciation. If we were to sell our property at a 6% CAP today, we could sell it for $340,000. At a 5.5% CAP, the listing price would be $370,000. 

 

How do you turbocharge your growth with forced appreciation?

If you are planning to hold onto your properties, the only noticeable impact on your finances is the increased cashflow. 

The increased equity in the property just sits there until you do something with it.

This is where you are going to want to tap into what we call lazy equity.

There are two ways you can tap into the equity.

One is to sell the property and do a 1031 exchange into a larger property. We have started doing this with our portfolio because we want to generate depreciation losses from cost segregation in order to shelter our income from taxes.

The second is to do a cash-out-refinance and free up the equity that was sitting in the property and buy another property.

Suddenly the money you had in the property that was making you 10% cash-on-cash is making you another 10% cash-on-cash in a different property. So you get two properties for the price of one. 

So, if you don’t have much money to invest, forcing appreciation allows you to re-use your same pot of money over and over again to grow your portfolio.

That’s why it’s the most powerful of the types of appreciation and, arguably, one of the most powerful ways to grow your wealth quickly to real estate investing. 

Have you successfully forced appreciation on a property? Do you have a unique property story? Join our Facebook group and share your real estate investing experience with our community of like-minded physicians and high-income professionals! Also, don’t forget to join our physicians or professionals groups!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD  Facebook page and join our Doctors or Professionals  group!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

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Hi, we’re Kenji and Leti

we provide coaching and mentorship for doctors and high-income earners

Several years ago, we were newlyweds working as full-time hospitalists. On paper, it looked like we had everything: the prestigious careers, the happy marriage, the luxurious rental home, the cars, etc.

But in reality? Despite having worked for several years, we had very little savings. Despite our high income, we had very little freedom in terms of time or money.

One thing was clear: we had to do something.

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