One of the greatest ongoing debates in real estate investing has been whether you should invest for cash flow or for appreciation. Which investment model is better for you depends mostly on your reasons to invest in real estate and for how long you plan to keep your property. If you are in real estate investing for some extra monthly income and you don’t plan to keep your property for more than 10-15 years, then you should focus on the cash flow, i.e., the amount of money left from the rent you charge after you cover all expenses. If, on the other hand, you are in real estate with the goal of selling your property in the long run after the price has risen significantly, then you must concentrate on real estate appreciation.
There are many factors which determine real estate appreciation, some of which are more obvious, while others are rather obscure.
If you are looking for an investment property and to a lesser extent if you are looking to buy a home, don’t allow yourself to overstress the appearance and the structure of the property. Of course, the actual physical property is important especially if you plan to live there yourself in the long term, but that’s actually what depreciates in value year after year. Regardless of how beautiful your property is, the physical structure will lose its worth over time. The IRS also acknowledges that as it factors in depreciation in determining taxes. In addition, maintaining the property will require more and more capital investments over time to keep it running. Thus, you must focus on the land. Land does not only decrease in value as it ages; on the contrary, it is what drives real estate appreciation. As the population is constantly increasing, more people are looking for homes, more and more properties are getting built, land becomes more and more expensive. So, if you have the option of buying a larger and nicer house on a smaller piece of land or a smaller and less luxurious building on a larger piece of land for the same amount of money, go for the latter. This will bring you more real estate appreciation in the long run.
The second factor determining real estate appreciation is closely related to land. Once again, the actual physical structure is only of secondary importance. Real estate property value at any point is a function of supply and demand, while the appearance, the functionality, and the maintenance of the physical structure have a lesser impact. Location is the key! Location refers to many aspects – the state, the city, the neighborhood, the exact place within the neighborhood. Locations within markets with higher population growths, better economies, more developed infrastructures, and off main roads are in higher demand and are also more likely to provoke real estate appreciation in the future.
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3. Future Development Plans
The currently existing infrastructure will significantly impact the market value of your real estate property at the moment. In addition, though, you should also study the governmental and commercial plans for the further development of the area in the future. If you buy a decent house in a not very lively suburb which is scheduled to undergo major infrastructural and commercial developments (connection with the city, schools, hospitals, banks, restaurants, etc.) in the next 5-10 years, you are guaranteed to benefit from massive real estate appreciation.
4. The Physical Structure
Although we kept repeating that the structure and functionality of the building are not the number 1 factor in real estate appreciation, they still do matter. Generally smaller, less attractive properties tend to appreciate faster. There is a pretty simple explanation for that, once again related to land. Let’s say you have two houses on equal land parcels next to each other, one of the houses being twice bigger and thus more expensive than the other. Both land parcels will appreciate by the same amount over a certain amount of time. So, while the bigger house will gain for example only 10% in value, the market value of the second one will rise by 20%. It turns out that the smaller, cheaper house provides a better return on investment.
5. The Economy
While you can control the physical structure and the location of your real estate property, there are other determinants of real estate appreciation that are well beyond your control. One of them is the economy – the local economy, the national economy, and the global economy. As we mentioned above, locations within more vibrant local economies will appreciate more over time. Moreover, if the US economy is doing well and people are employed, the demand for housing will increase, which means that prices of both land and properties will go up. Similarly, specific large economies and the global economy as a whole affect the US stock market, which in return impacts the entire US economy.
6. Interest Rates and Lending Guidelines
Another important factor which will influence not only your property’s real estate appreciation but the whole housing market is the interest rate and the related lending guidelines. If the Fed pushes the interest rate up, people will be less able to afford loans, which means that real estate prices will go down. In reverse, lower interest rates will push prices up as more people will look for homes. Similarly, tighter lending guidelines, like those imposed immediately after the housing crisis, will disqualify any potential buyers. Loosening guidelines, on the other hand, will make it easier for more people to afford buying a home, which will bring prices up.
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Finally, there are many other factors which influence the real estate market and could lead to real estate appreciation or depreciation. These include demographics (how fact the population is growing), the availability of building materials, and foreclosures, to list a few.