Not many investments will outpace inflation if just left alone.
Most common investments by retail (individual) investors such as stocks, bonds, money market accounts, annuities, and CDs have all underperformed against inflation over the past 20 years.
Beyond dividend stocks, investing in stocks is a hold and hope game. You hope the value of the stock appreciates in order to sell it at some point in the future. It’s beyond your control to accelerate appreciation. You may think buying more Nike shoes will help the stock appreciate, but it doesn’t even register.
Market appreciation is at the mercy of the markets.
This includes Twitter comments from the President, opinions of the talking heads on CNBC, new tariffs imposed, public opinion, an expose’ on child labor of the company, and many more things beyond your control.
However, investors who only rely on market appreciation are missing out on the major advantage that commercial real estate has over all other investments.
Real estate has one unique element called “forced appreciation” or value-add appreciation. I like to call it proactive appreciation because it is something we can control.
Market appreciation is the natural appreciation of an investment over time. It is a natural result of supply and demand. In terms of real estate, as populations grow, the real estate becomes scarcer as it is being consumed.
Not all real estate will appreciate over time, and not all markets will appreciate equally.
Market appreciation is all about location, location, location. Properties in questionable areas of Detroit, Cleveland, and Philadelphia may actually depreciate over time. Compare this to Los Angeles, Manhattan, and Miami where market appreciation accelerates steeper than say in the Midwest, and you can begin to understand the importance of location for appreciation.
With multifamily properties, market appreciation can occur with growth in population, new businesses moving in, and other factors that affect supply and demand. Natural market appreciation will occur as long as the number of renters with jobs continues to grow, and this has been an upward trend since the Financial Crisis, where supply has easily outstripped demand year after year.
If all you’re counting on is market appreciation for a return on investment, location will be the critical factor in making investment decisions. Simply by being in the right location and the right market, you are more likely to increase your wealth from market appreciation over the long-term. I say long-term because although gateway markets like LA, New York, and Miami appreciate more than non-gateway markets over time, in downturns, they also fall harder than other markets. So don’t bail at the earliest sign of trouble because these markets also tend to bounce back faster than others.
Investing for the long-term is key to benefiting from market appreciation unless you’re an investor who’s good at predicting real estate cycles and can take advantage of the cyclical rise and fall of real estate values.
Natural market appreciation can be good, but for creating real wealth, forced appreciation is more predictable, and it is what sets real estate apart from every other form of investment.
Value-add means we can add value to the property to increase its value and not depend on market appreciation.
The list of actions we can take to force appreciation (add value) on a property is long and varied. The typical strategy for forcing appreciation is to improve net operating income (NOI), which in turn improves cap rates and long-term value. Investors can force an increase in NOI by increasing revenue, decreasing expenses, or both.
Here are some typical strategies for improving NOI:
- Adjust rents to match market rates
- Add amenities and capital improvements
- Improve screening to acquire higher quality tenants
- Make cosmetic improvements to enhance curb appeal
- Invest in energy-saving and water-saving enhancements that will reduce utility costs
- Improve operations and the property management system often increases efficiency and reduces expenditures (costs)
These improvements increase occupancy, which also increases the value of the asset. By increasing NOI, the value of the property is “forced” to increase as cap rates rise accordingly.
The true key to long-term wealth is to be proactive in forcing the appreciation of your investment property or rely on someone else to force that appreciation.
By leveraging informational advantages to exploit value-add opportunities and by leveraging management experience, expertise, and operational efficiencies to improve NOI, investors will be able to grow wealth exponentially by forcing appreciation on these value-add opportunities.
Even small improvements each year will make a big difference in the long-run as the value of the property increases exponentially with your improvements building on each other, making the whole greater than the sum of the parts.
And whether you invest directly or partner with an experienced team like TruePoint, an investment strategy involving forced appreciation maximizes your chances of achieving true wealth and financial independence.
Investor, writer, speaker, and founder. Kyle Jones, key principal of TruePoint Capital, is accountable for investment decisions, asset management, and overseeing financial activities, operations, and investor relations. Kyle additionally is a Global Sales Leader for a large Fortune 100 technology company. Kyle received a Bachelor of Science degree from Texas State University – San Marcos.