The Price of Appreciation

[Dan DiFilippo]

Appreciation is not the most tangible or stable factor in real estate investing.  Its effects are varied throughout the different markets around the country and it is less concrete than cash-flow.  There are arguments to be made regarding appreciation as a result of half a century of sustained debt-based monetary expansion in concordance with demographics.  And how the coming end of that growth cycle is signaled by interest rates being at civilizational lows (even pre-COVID).  These are certainly legitimate arguments and I have made them myself on these forums.  And are worth any investor's comprehension.

However, I would like to review appreciation on a secular basis.  Because even on this level, I think the concept is sorely underappreciated.

Many people take appreciation for granted, but I would argue that there is a "price" that must be paid in order to "gain" an appreciation of value.  I will demonstrate using a breakdown of some capital-related costs.  Keep in mind, I operate in the Fayetteville area in North Carolina.  I will be using revenue and cost numbers that pertain to that market.

Assume a rental home worth roughly $100,000 that rents for $1,000/month (not uncommon here in Fayetteville). It may be a 3/2 around 1,250sqft. Not everyone agrees on how to even approach CapEx, but many investors will simply underwrite some 5% of gross receipts for CapEx. $50/month in this case. Let's see if this is enough. Major concerns will be HVAC, roof, flooring (especially carpet), and paint. HVAC might last 10-15 years. I tend to go with 12. Roof will maybe get you 20. Floors will probably need some redoing closer to 15 years out. And the walls will need a repaint every, maybe 10 as well. So what do we have in those cases? 12 years by a $6,000 HVAC installation. 20 year roof for $6,000. A mix of refloorings at an average $4/sqft all throughout the home over a 12 year period will cost $5,000. And then $2,500 to paint, figuring every 10 years.

Taken over 30 years, we are looking at $15,000 on HVAC, $9,000 on roofing, $10,000 on floors, and $7,500 on paint.  Or $41,500.  If you want your home to appreciate in value, you're going to have to pay this.  Otherwise you are leaving your home in a worse shape than you bought it in and it will fail to meet appreciation targets.  Almost $1,400 each year.  Just under 12% of gross rent.  This figure is reckonable and, I believe, under-accounted.