How to Calculate Appreciation for Single-Family Rental Properties
By Scott Pastel, VP of Marketing, Marshall Reddick Real Estate
It’s common knowledge that real estate is an appreciating asset. However, we all know that geographic markets across the country can perform very differently from one another. The question is, “How much appreciation can we expect on a single-family investment we’re considering before we pull the trigger?”
When looking at individual MSAs (Metropolitan Statistical Areas), the housing market has lots of little ups and downs over the short-term. A typical trend is that properties in coastal, sunny states have greater variability in their appreciation, whereas properties in the middle of the country appreciate more steadily. Despite these ups and downs in the short term, the general trend for all markets has historically been exponential upward growth. This is because once a property has increased in value it retains that value for the next year, so appreciation builds on appreciation from previous years. This is known as “compound appreciation,” a key benefit that most real estate investors are not aware of.
So how do we actually calculate appreciation? First, we have to look back at the historical trends of properties in each market. Then, we have to look forward and predict how the property value will grow.
We recommend using a 25-year average appreciation rate, which we can determine by looking at the median value of single-family properties in a given MSA each year for the past 25 years. Using a long period of time produces more accurate predictions because it averages out short-term fluctuations in the market and includes at least one cycle of the real estate market.
It’s impossible to make perfect predictions about how any individual property will appreciate. However, you can get very close if you know two things: 1) The average annual appreciation rate in the MSA over the last 25 years, and 2) The classification of the property you are evaluating.
Marshall Reddick Real Estate has created the only nationwide property class rating scale for SFRs in the country, known as the Reddick Property Rating™. You start by obtaining the median house price in the MSA you are looking at. Let’s take Atlanta, Ga. for example. The median house price in Atlanta as of the second quarter of 2015 is $181,500. Using the chart below, you can obtain the property class in any given MSA:
Let’s take an example. If you are looking at a $100,000 house in Atlanta, it would be considered a C-class house because it is 55 percent of the current median house price of $181,500. Keep in mind that not all houses in a given MSA will experience the same rate of appreciation over time. The 25-year average appreciation rate typically mirrors that of a B-class house. It’s generally safe to add 0.5 percent on top of the average annual appreciation rate for an A-class house, and subtract 0.5 percent of the average annual appreciation rate for a C-class house. Keep in mind that different property classes provide different benefits; neither is necessarily “better” or “worse.” The easiest way to remember each benefit is to associate “A” for Appreciation, “C” for Cash flow and “B” for Both.
The formula for compound annual appreciation is A = P • (1 + i) n, where n is the number of years held, P is the principle (or initial value of the asset), i is the interest rate (or appreciation rate), and A is the final value of the asset. In the case of the current median house price in Atlanta, $181,500, we begin by obtaining 2 percent for the annual average appreciation rate over the last 25 years (given by NAR data) and adjust it to 2.5 percent since it’s an A-class property. Let’s run the example with a 10-year hold to see what the compounded appreciation and final value of the asset look like:
Formula: A = P • (1 + i) n
End Result: $232,335 = $181,500 • (1 + .025)10
With a current value of $181,500 and a future value of $232,335, we can see that we gained $50,835 in appreciation over the 10-year period using our given appreciation rate.
When running your analysis to calculate return-on-investment, it’s best to use at least a 10-year hold period as the default. This strategy helps when leveraging a property with financing because you pay off a higher percentage of the principle on the loan as it matures. It also enables you to reap the benefits of compound appreciation over time. Make sure to use a proper Property Financial Calculator to ensure that you are factoring in all necessary expenses including fixed and variable expenses.
B2R Finance offers rental investors innovative lending products to help unlock equity from existing portfolios and provide the cash needed to build rental portfolios nationwide. For more information about how B2R can help you obtain rental property financing, just call 800-227-8107 or visit http://www.b2rfinance.com/apply-now and follow us on Twitter @B2RFinance.
The information on this page is provided for informational purposes only and does not constitute investment, real estate, or legal advice. This information should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. No representations or warranties whatsoever, express or implied, are given as to the accuracy or applicability of the information contained herein. The information may be modified or rendered incorrect by changes in the marketplace or developments in the law, or for any other reason, and may not be applicable to any individual reader’s facts and circumstances.