Appreciation based on cash flow or Surrounding neighborhood

Green Bay, WI · Member since 2016 · 15 posts · 3 votes

I recently read that commercial real estate even small apartment buildings appreciate based on cash flow not on the surrounding neighborhood like single family homes do. I am wondering if that is accurate and exactly what types of properties appreciate based cash flow i.e can it be a fourplex in a residential area or does it have to be say an 8+ unit apartment building? I always thought the surrounding area would have at least somewhat of a factor in dictating appreciation for any property.

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Thomas S.

Member since 2016 · 13k+ posts · 12k+ votes

10y

Value is based on income for experienced investors business investors. In my case a property, excluding single family, is only valued on income. This is the primary reason investors strongly advise raising rent when ever possible. Condition of property of course also plays a part in regards to deferred maintenance. Individual investors will of course value differently based on the cap rate they determine fits their business formula.

This will apply to all specific purpose rental income properties excluding single family. Single family extends to duplexes with separate addresses.

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Sarah Ziehr
Real Estate Broker · Chicago, IL · Member since 2015 · 531 posts · 266 votes
10y
Property appreciates based on your local real estate market- market value- and improvements you make to to the real estate including general maintenance and upgrades.
For commercial or investment property, you are generating revenue through the rents as well as realizing any appreciation once you go to sell.
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Thomas S.
Member since 2016 · 13k+ posts · 12k+ votes
10y
Value is based on income for experienced investors business investors. In my case a property, excluding single family, is only valued on income. This is the primary reason investors strongly advise raising rent when ever possible. Condition of property of course also plays a part in regards to deferred maintenance. Individual investors will of course value differently based on the cap rate they determine fits their business formula.
This will apply to all specific purpose rental income properties excluding single family. Single family extends to duplexes with separate addresses.
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Andrew Hooyman
OP
Green Bay, WI · Member since 2016 · 15 posts · 3 votes
10y
Thanks for the replies. I am planning on targeting properties that give me a cash on cash return of 15+% with a reasonable conservative chance of 2% appreciation a year. Hopefully this isn't unrealistic. So basically as long as maintenance is kept up and I can raise rents I should have a good chance of achieving 2% appreciation each year?
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Brent Coombs
Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
10y
@Andrew Hooyman, question is, who can guarantee you future appreciation? Does it ever go up in a nice steady gradient, with no bumps or dips?
Really, all we can do is: have a "best guess", cross our fingers, and the chips land where they may!
So when you read "that commercial real estate even small apartment buildings appreciate based on cash flow not on the surrounding neighborhood like single family homes do", BOTH of those measures are HISTORIC, after-the-event statistics anyway!
You might notice in small print next to an asterisk on some investment ads: " indicates past performance; not proof of future outcome".
Pay attention to that small print! Cheers...
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Scott TrenchPro Member
Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
10y
@Andrew Hooyman Commercial real estate investors like to use a thing called "Cap Rates" to determine the value of income property. A cap rate is this:
net operating income
/
property price
Or in an example
Net Operating income = $10,000
Property Price = $100,000
Cap rate = 10%
If the cap rate changes to 5%, and the income stays at $10,000, then the property value increases to $200,000.
So the income that your property produces of course is reflected in the purchase price.
But, in many cases, cap rates are determined by the neighborhood, city, market conditions, and property specifics. A property in disrepair in a crappy part of town is going to have a higher cap rate (I'd need more income per dollar of purchase price) than a beautiful office park in a really nice part of town (I'll take less income, for more potential).
Therefore, you have two ways to seek appreciation in commercial properties:
1) Increase the income of the property
2) Purchase properties in parts of town that are likely to improve - as conditions improve and expectations for future growth increase, cap rates will fall, and prices will increase.
Was this helpful?
It's the same thing pretty much as buying residential homes - nice areas or areas with certain characteristics are likely to improve and increase in value.
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Sarah Ziehr
Real Estate Broker · Chicago, IL · Member since 2015 · 531 posts · 266 votes
10y
In my experience cap rates are just an indicator for investors.
They see a nice cap rate, then they fly into Chicago to view the property. If they see there is deferred maintenance, or if they don't like the area, or they don't like the tenants, they don't invest.
Betting on 2% appreciation would really depend on the market you are going to invest in. In hot markets like Chicago prices can be very stable over time and rents may or may not rise every year. If you have positive cash flow then is appreciation really the most important factor?
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Jeff B.
Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
10y
I've always depended upon the NOI itself. Cap rate is 'colored' by the PP and becomes subjective. The NOI leads to the cash-on-cash which become deposits to your account - - cap rates are like golf handicaps -- topic for discussion at the 19th hole (aka club house).
Appreciation is totally uncontrollable, so I ignore it. That being said, mine is going to be a great present after 18yrs and the timing is very unrepresentative of the norm, especially short-term holds. But I invested in the cash-flow and I got a cash-flow - - smiling all the way to the bank.
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Andrew Hooyman
OP
Green Bay, WI · Member since 2016 · 15 posts · 3 votes
10y
@Scott Trench Thanks your post was very helpful. I had heard a lot of investors say you want to buy at high cap rates going in and sell when the cap is low. This now makes more sense to me. Your two ways to seek appreciation are what I originally had in mind, much clearer now.
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