Sam's Home Buying Tips

Maximizing Home Appreciation

Sam’s Home Buying Tips
January 2008

How often do you hear the expression, “homes always appreciate?” This is a myth that must be understood for buyers seeking to maximize appreciation. Let me explain.

Every real estate transaction can be broken down into two parts: the land and structural improvements added to the land such as a home, patios, walkways, fencing, and pools. Many buyers don’t realize homes and other improvements actually depreciate over time, even with the inflating cost of labor and materials. This is because as homes age, they experience wear and tear liabilities (e.g., roofing, siding, appliances, finishes, heating and cooling equipment) and become outdated relative to new homes (e.g., technologies, construction practices and design features). In contrast, the land each home sits on typically goes up in value as property becomes more scarce and landscaping, trees, and foliage become more mature.

The reason real estate historically goes up in value, is that the land appreciates at a much greater rate than the depreciating structural improvements. Ongoing maintenance and upgrades can help minimize or eliminate the depreciation on the home. However, these home ownership costs must be factored into any calculation of total real estate appreciation. For instance, a property bought for $300,000 and sold for $400,000 should not be assumed to incur $100,000 appreciation. If $60,000 was spent on maintenance or improvements, this amount must be subtracted from the gross appreciation resulting in a net appreciation of $40,000.

Based on this understanding, the wisest strategy for maximizing real estate appreciation is to choose property where the land represents the largest component of the price. This is the core concept behind common real estate investment adage "buy the worst home in the best neighborhood you can afford.” Let’s do the math to demonstrate the potential impact on net investment.

Assume a scenario with two real estate investment options valued at $400,000. In option number one, the house is a beautiful large home in a modest neighborhood where the real estate deal breaks down into a house valued at $350,000 and land valued at $50,000. In option number two, the house is a fixer upper in a high-end neighborhood where the real estate deal breaks down into a house valued at $150,000 and land valued at $250,000. In both cases it is assumed that the land appreciates at 8 percent annually while an unimproved home and other structures depreciate at 1 percent annually. After the average term of home ownership, 7 years, simple mathematical calculations reveal that real estate option number one is worth approximately $410,000 while real estate option number two is worth approximately $570,000 (see detailed investment table below). Thus, by investing in real estate maximized for land value, the buyer in this scenario will realize approximately $160,000 of additional income. Of course this doesn’t factor in compromises such as potential comfort, health, and enjoyment issues living in a “fixer upper” home, but it demonstrates the dramatic difference in income potential based on home selection strategy chosen. To break down real estate options of interest for you and your family into land and structural improvements, go to “Mistake No. 10 – Not Evaluating the Deal” in Sam’s Home Buying Tips.

Table: Two Real Estate Investment Options
Annual Assumptions: 8% property appreciation, 1% home structure depreciation

$400,000 Real Estate Investment

Option #1

Option #2

Year 

Land

Home

Land

Home

2008

$50,000

$350,000

$250,000

$150,000

2009

$54,000

$346,500

$270,000

$148,500

2010

$58,320

$343,035

$291,600

$147,015

2011

$62,986

$339,605

$314,928

$145,545

2012

$68,024

$336,209

$340,122

$144,089

2013

$73,466

$332,847

$367,332

$142,649

2014

$79,344

$329,518

$396,719

$141,222

2015

$85,691

$326,223

$428,456

$139,810

Total Value

$411,914

$568,266

Disclaimer

The information provided on the Sam's Home Buying Tips web site and "How to Avoid 10 Biggest Mistakes Buying a New Home" guide represents the best professional judgment of the author based on 20+ years experience as an architect, 10+ years experience working with the nation's home building industry to establish more efficient building practices, and wide experience advising friends and clients on new home purchases. The information provided on this web site does not address all possible concerns involved in purchasing a new home and is not intended to guarantee that difficulties or problems won't be encountered with a new home purchase based on the advice provided.

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