What is Appreciation?
The main force that pushes the value/price of something higher is when demand outpaces supply. Things that have a limited, finite supply tend to rise in price over time even if the demand for them were to stay constant. This would include things such as land/property, natural resources, or the publicly-traded shares of a profitable company. Inflation also plays a big role here; in general, the prices of things rise over time, manifested in the expression “a dollar doesn’t buy what it used to.” The rate of appreciation on a real estate property is either higher than the rate of inflation over the same time period, or else the property is actually losing value.
As it relates to a home or investment property, appreciation can occur in one of two ways. First, appreciation can happen “organically,” simply by the passage of time, possibly because of something like gentrification. Home prices have generally risen in the past 100 years, partly due to population growth and economic expansion, and partly because of inflation. The second way appreciation can happen to a property is “forced appreciation”—making improvements to a property to add value to it. Investing in a property via renovations and improvements is considered a good use of capital and can even lead to more gains in appreciation than were spent on the upgrades.
There is an important distinction to make here: Most physical assets actually depreciate over time. The reason for this is simple—things break down and get old! And this reality certainly applies to homes; while home values may rise over time, it is the land that is almost always providing the appreciation, not the physical structure sitting on top of it.
Appreciation’s Implications to Finance
The same goes for a home equity line of credit (HELOC) or a construction loan a borrower wants to take out; both of these loans would involve the lender agreeing to timestamp the current market value of the property being borrowed against.
When considering the prospect of real estate as an investment, the most pragmatic approach is to consider the investment on the basis of its predictable income and cash flows rather than on its appreciation potential. While history has a good track record of rising home values over time, to an investor, short-term cash flows are much more important.
The actual amount a property may rise or fall in the future can only be estimated, never known. But a prudent investor can estimate monthly income and cash flows on an investment property with a high degree of certainty—and this is what should determine whether a piece of property is a good investment vehicle.
How Can I Determine How Much My Home/Investment Property Has Appreciated?
But what if you’ve renovated, repaired, and upgraded the property, putting your own money into making it more valuable? It’s common practice to add the total amount you’ve spent on home renovations to the value of the property in a straight-line fashion. Therefore, if you’ve spent $25,000 on renovations since you took out your mortgage, you can expect your home to have appreciated at least $25,000 from the endeavor. Ideally, you expect to see more than $25,000 added to the value of the home, but the bare minimum is to get an equivalent value for cost.
In order to get a more refined sense of your property’s current value, you’ll need to get an appraisal on your property. An appraisal is standard practice for anyone looking to buy a home or to refinance one they already own. For a fee, an appraiser will come to your home and evaluate the property up close, and report back to both you and a lender you may be working with on a refinance loan, construction loan, or HELOC. Alternatively, an appraiser will be hired by a prospective buyer if you’ve put a property on the market for sale to get a real-time sense of the value of the home.