Why is the "appreciation perpetuity" being ignored when valuing properties?
An investor who invests in a property with an 8 cap return for a hypothetical amount of $1,000,000 will earn $80,000/year in cash flow. I
The 8% return provides the investor a strong return which is about equal to the 8.4% return for stocks between 1990 and 2008. However, the overlooked aspect of the investor's return is the appreciation of the property. The property's value will likely increase at at least 5%/year over the long term. If the investor holds indefinitely, the property owner is basically receiving a perpetuity in the amount of $50,000/year. At a conservative 10% discount rate, this appreciation factor itself has a NPV of $500,000. That means the value of this investment is $1,500,000 whereas it's only being valued at $1,000,000 based on the cap rate (the cap rate seems to provide a sufficient return on its own that justifies the $1,000,000 investment value.) Why would someone ever sell a property and give up the appreciation perpetuity that comes from "buying and holding" indefinitely?
The above analysis is an un-leveraged scenario which also doesn't even take into account tax benefits.
Am I missing something? This seems too good to be true and I can't understand why anyone would ever sell? Why isn't the appreciation factor taken into account when valuing real estate?
Most Popular Reply
#5 All Forums Contributor
- Plymouth, MI
Answers in the form of questions:
1 - Have we experienced a time(s) recently when the assumed equity built up from appreciation wasn't there?
2 - What good is appreciation unless you can use it?
3 - How do you access the equity built by appreciation?
4a - How many pizzas deliveries have you paid for with the equity build up through appreciation?
4b - Have you ever been able to figure out (I haven't) which part of the house is equity (appreciated or paid off) so you can maybe use a brick or two to buy the pizza?