Appreciation - Part I

It all started many years ago, after I purchased my first home. It wasn’t an investment property, but rather the one in which I was to live. I knew nothing about real estate and even less about investment strategies. I simply wanted a place to live, hang my hat and call my own. The house was new construction, in an up-and-coming neighborhood, and I was excited about finally becoming a homeowner. After 9 months of watching the construction process, my wife and I finally closed the transaction. A good while later, I decided to establish an equity line in order to access my down payment in the case of an emergency. To my surprise, the bank’s appraisal determined the property was worth $20,000 more than when we had purchased it. Somehow, over the course of time, I had minted money. Somehow, my original investment was now worth more than it was originally.

What I had discovered during my first foray into the real estate world was due in part to the power of appreciation! This phenomenon enabled me to create money out of thin air! Since I wanted to repeat my efforts and purchase more property, I had to figure out how to use this wonderful tool to my advantage.

Shortly thereafter, I discovered other ways to make money in real estate investments. In fact, investors can make money in four unique real estate profit centers: 1) profits from positive cash flow 2) equity growth from loan balance reduction 3) tax savings and of course, 4) equity from appreciation. With a rock-solid game plan and a fundamental understanding of each of these profit centers, investors can create a monthly income from their cash flow, receive tax savings by writing off expenses and depreciation, and can mint money through tenants retiring their debt and through appreciation. Since appreciation is based on the full value of the asset and not the amount of money you invest therein, it can often yield the greatest gain of any of these profit centers.

Unfortunately, appreciation is not usually a short-term money-maker. Appreciation may take effort to harvest, and since significant appreciation occurs over time, it usually requires tenacity and perseverance on the part of the investor to hold a property for years in order to ‘mint’ money. Keeping this in mind, we also know that there are two approaches to real estate investing: short-term and long-term. Most beginners are anxious and feel they must create an income right away. These investors are sometimes referred to as ‘wholesalers’ or ‘flippers’. They purchase property below market value and resell it almost immediately at a higher value, thus realizing a short-term profit. To me, this is simply a glorified salary, a job. They rarely realize the benefits of appreciation. Then, there are your buy and hold strategists. These investors have longer range goals in mind. Rather than concentrating on purchasing property and immediately turning it to another investor for a small profit, they are more interested in keeping the property long-term in order to realize the long term benefits of property ownership, especially gains from appreciation.

Many investors are hesitant to buy and hold for long-term wealth creation. “What if I can’t rent out the house? Will property values really rise in this area? I need cash now! I don’t want to be a landlord!” Of course, the list of excuses continues. The truth is that in order to create long-term wealth, investors MUST factor appreciation into their game plan. In other words, they must be willing to buy and hold. Certainly, I am not advocating that you use appreciation as the cornerstone of your investment strategy. Use several strategies, working in tandem with one another to produce a successful game plan and profitable investing business. Some investors use appreciation and tax deferral from depreciation as their ‘gravy’ money. These investors make sure than an investment is sound on a cash flow or short-term profit basis before they proceed with their purchase. However, others are willing to put their plan in a negative cash flow position if they feel that the end justifies the means. In other words, they may feel they can make $30,000 if they can simply hold onto a property for 5 or more years. Yet, in order to get from here to there, they must accept less in rent than they are paying in monthly debt service and expense outflows.

Once again, I reiterate that appreciation is a long-term wealth creation strategy. If investors are willing to wait, they just may find themselves minting money through appreciation.

(Don't miss, Appreciation - Part II) Coming soon!