Forced appreciation
Palatine, IL · Member since 2016 · 12 posts · 5 votes
Hey everyone, so I have made a few posts now and here is my next question. I am most interested in buy and hold investments, I have done enough research and reading to get the concepts of it and the term I have heard over and over again is "forced appreciation" which I read is used at purchase price, typically a 10 percent forced appreciation if I remember correctly, my question is how do you determine what 10 percent is and how much money is required to do that relative to purchase price of home or purchase price of the "forced appreciation". The next question is tied to the first when you do finally force appreciate the property what should be looked at first or appreciated as a rule of thumb? Thanks everyone
Hi, Nikolas.
It's my understanding that forced appreciation applies to multi-family, over four units, so property that is valued according to its cash flow, not using comparable properties.
Forced appreciation, to me, means that you find a way to improve the cash flow, either by raising rent reveue or decreasing expenses or otherwise improving the performance of the property. By improving performance, you are "forcing" the value of the property to appreciate in value.
It often comes into play at purchase time when you recognize you have a property that is not living up to its potential, and you pay less that what you know it will be worth with your improvements. If you buy it, improve it, then sell it, you will have forced appreciation in value.
If you buy, improve, and hold, perhaps you will be able to refinance and then take cash out of the deal based on how you improved its performance.
I'm not clear on what the 10 percent numbers you are referring to mean, or how you would purchase forced appreciation. Maybe the 10 percent is an illustrative cap rate someone was using to value properties?
I suggest you read this article. Ben Leybovich is a great source for this topic.
https://www.biggerpockets.com/renewsblog/2015/12/01/forced-appreciation-work/
@Miguel Perez you have answered all of my questions and more! Thank you for the thorough answers and input! Much appreciated!
@Miguel "Mike" Perez - 3 months later, did a search and found your response valuable! Thanks for the insight.
I'm retiring and selling my 18yr B&H 6-units. I forced appreciation over the years by improvements and rent increases. 10%? I would be embarrassed at that number. The economic appraisal (the ability to command rents) came in at $770k, my original purchase was $305k - - you do the math. Original price/unit was $54k, today target was $122k, but full price offer turned into $128.
Savvy investors also "force" appreciation by simply buying UNDER actual market value - which can be proved once the Banks allow a re-appraisal (usually after at least 6 months)...
The same concept of "forced appreciation"holds for both residential and commercial properties, though the mechanics of how the value of the property increases are different. It is the primary way that flippers make their money, but it can also be applied to buy and hold. The concept is to buy something at a discount that is not up to the market standard, then bringing it up to market standard (and therefore "force" appreciation up to market price) after purchase. The key is to acquire the property at a discount that makes it worth your time and effort to improve it. In other words, the cost you spend to renovate up to market standard needs to be much less than the value you add by doing so. Another key is that you are simply bringing the property up to current fair market value for a turnkey property, so this type of "forced appreciation" is something that YOU create through sweat, knowledge, skills, and extra investment in renovation, rather than something the MARKET creates for you with rising property values ... for this reason "forced appreciation" is often considered less speculative and certainly happens much faster than "market appreciation", though it is a lot of work.
The key with rental income properties is to find the ones that are mismanaged. The mom and pop that never raised the rents. Or that landlord that holds their tenants rent $100 below market because they are such good tenants. You pay a purchase price based on the actual income then immediately raise the rents when you take ownership. You risk some vacancies but when rented at the higher rate you automatically increase the value of the property.
IN the case of a SFH that does not cash flow you look for the one that is the easiest to add that legal secondary suite in the basement. Without a secondary SFHs rarely cash flow so your offer will be based only on what the existing rent will support.
You need to find tired worn out landlords that are not willing to live through another bad tenant. They are the weak animal in the heard and easy pray. The older ones have no mortgage and are willing to take less just to get out.
I've been reading the the BP book, Rental Property Investing, to get a good grasp on things before I jump in and the 'forced appreciation' was something that was vague (only halfway through the book). But I think this thread is mixing terms. I would agree with @mark and @Thomas S. Your goal is to get a great deal going into it (70-80% of ARV) as mentioned here. So you have 30-20% in repairs and curb appeal, accordingly. But the 10% 'forced appreciation' is finding an opportunity- an undervalued and/or mismanaged property that can be capitalized with increased cash flow.
Aw, I love this topic and have written many posts on the issue. @Nikolas Buchholtz and @Andrew Conway don't limit yourself. There are unlimited ways to increase your net operating income and force your appreciation. Here's a post where I detailed my journey.
I've since have gone one to pay 100% of my mortgage with side income, so technically I've almost doubled my values. BUT a bank won't give me credit for all my income that isn't attached to a lease agreement/contract.
I'm working now to tie all my extra income to contracts so an appraiser will recognize the income and add that in with my appraised values.
Hi, so does forced appreciation only work on 5+ units since even r4 is considered residential and so it will use comparable sales even if you do forced appreciation on it? 5+ is considered commercial thus value is dependent on noi. When you increase noi the value goes up. It's much easier to see and able for banks etc to calculate this easier to refi and sell at the higher value.
Therefore if I want to utilize forced appreciation, then it's better if I buy 5+properties. Am I analyzing it correctly?
@Lena Wang, no, the mechanisms to "force appreciation" would be the same for either, but, are likely to be quantifiably different between residential and commercial. eg. Spending $60k on improving bathrooms and kitchen may force a residential home's value up by $100k (by buyer demand), but have relatively little increase on its Rent-per-month value.
Whereas for Commercial, you're mainly looking for buildings that are currently rented out too cheaply compared to their potential, and your "NOI improvement" budget may be spent very differently than worrying about cosmetics. Right?
Yea i agree with what you said on the residential part, but i think commercial many ppl look to rehab it, increase value through increasing rent, decreasing cost, thus increasing NOI, thus value. LIke for 5+ units many ppl will buy prop that's under value and needs work, fix it up, rent it out, sell or hold. Same goes with office buildings. I think this is just in addition to what you said.
Thanks for explanation.