Forced Appreciation in Commercial Properties: What Investors Should Know

Oh yeah, real estate investors can use the force, too!

Especially those who own commercial properties that are valued-based on the net income they generate.

Here’s how forced appreciation in commercial properties works

If you can get your rental to generate a little more income, that income is divided by a capitalization rate, and that’s the value your property will appraise for. So you can force your value up by increasing your income stream.

That’s forced appreciation.

Different Kinds of Income Streams
But check it. Let’s look a little closer. While all income streams matter, some streams are better than others.

Let me illustrate: I’m known for chasing the dream of creating enough side income to cover my mortgage so my tenants’ rents are available for other things. (Listen to BP Podcast episode 11 to hear Josh laugh at me.) 🙂

Crazy goal, but I’ve kept the BP community updated, and now I’ve accomplished it. Woohoo!

Anyway, what’s interesting is that people (myself included) like to take the $1,750 extra side income and calculate the equity I’ve earned. It goes $1,750 x 12 / 0.10 cap rate = $210,000! Wow, I’m going to Cancun and going buy a Lamborghini like blogger Mark Ferguson!

But when I calm down, I realize that an appraiser is going to scrutinize my side income and see it could be transferred to a buyer.

In commercial real estate, like residential units comprised of 5 units or more, the buyer is paying for an income stream. They happily pay for lease agreements at market rate, but are less willing to pay for the revenue I generate from my bicycle sharing venture.

To get full credit, you need:

Contractual agreements that can be transferred to a new owner
A sufficient track record of side income streams

Growing Strong in “The Force”

We’re as all cash flow is good, but when it comes to using “the force,” not all streams are great. For example, income from my furniture rentals and bicycle sharing might be discounted. My corporate housing, Airbnb, furniture rental and payday rent income may be discounted. Lucas Hall’s contract with Zip Car and Roy N.‘s motorcycle/car garage storage income may be considered.

Now, I’m enjoying the cash flow. I like that my 8-unit is cash flowing like a typical 16-unit, but I’m doing the following to grow strong in “the force”:

Keeping good records of side income and basing it on contracts whenever possible.
Adding items that are closer to traditional, such as a storage unit.
Adding items to knock out expenses like thermo preheating hot water to eliminate hot water expenses.

How about you? There is a wide array of tactics you can invest in to force your appreciation. Are the ones you’re choosing going to get a full capitalization rate?

Let me know with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.