Over time, real estate appreciates. As inflation occurs, the costs of goods and services rise. With that, real estate will typically appreciate. While a property may decline over a short period, it will typically rise in value over time.
In multifamily, as market rent rises, there is a natural appreciation in value to the property, assuming the NOI, Net Operating Income, also increases.
Forced appreciation is when the value goes up due to renovating the property, adding income, or reducing expenses. This is similar to renovating the kitchen at your primary residence. When you renovate the kitchen, the value of the home will increase. Forced appreciation is not due to the market conditions. This is a result of the ownership creating appreciation.
Why do we force appreciation?
Our strategy is a value add strategy. We buy properties that need improvements and improve the community. When we force appreciation, the value of the property increases.
For example, if the Cap Rate of the market is 5%, and the annual NOI is $1,000,000, the value of the property is $20,000,000. Raising the NOI by $100,000 per year brings the valuation of the property to $22,000,000. By raising the NOI, the property is worth $2,000,000 more!
Valuation = NOI / Cap Rate
When we force appreciation, we increase the value of the property. We only target properties that can support the value add strategy of forced appreciation.