What is forced appreciation?

Forced appreciation is a strategy used to increase the value of commercial property by increasing the income and/or decreasing the expenses of a property.

When investing in multifamily, the investor has the ability to increase the value of a property through increasing the income and/or decreasing the expenses of a property, which is is often called forced appreciation. This is because commercial estate is valued based on the income the property produces.

Forced appreciation is one of the important differences between investing in commercial real estate (5+ units) vs residential real estate (1-4 units).

Market Appreciation

Most of us are familiar with single family homes. The value of a single family home is determined by the recent sale of comparable properties in the same neighborhood. If three properties comparable to yours sold for $300,000 over the last two months, then expect your property to be valued around the same. Of course conditions and special features of your property may play a part in the valuation - but the amount of income it can produce doesn't count for much.

This leaves the owner of a single family home little control over the value of their property. How much can you control the supply/demand of the area? How much say do you have in the neighbors that move in around you? How much can you control the condition your neighbors keep their property? On average, very little.

Forced Appreciation

Commercial real estate (5+ units) is not valued based on the sale of similar properties. It is valued based on the amount of income the property can produce. This gives the owner more control over the value of the property - they have ability to force appreciation.

Commercial real estate is valued by using the following formula:

 Property Value = Annual NOI/ Capitalization Rate

The capitalization rate is, in short, the return an investor can expect to get on invested capital. This number varies depending on the market and property class. Net operating income (NOI) is the amount of income the property produces less operating expenses, excluding debt service. 

One of the major goals of commercial real estate investors is to raise the NOI of a property, because increasing the NOI increases the value of the property. This is accomplished through a number of ways including increasing rents after renovations, implementing RUBS, adding ancillary income such as vending machines or coin laundry, and lowering expenses through efficient management. 

Example

A property is purchased in January 2017.

Year 1:

NOI = 300,000

Cap rate: 10%

30 units

Annual NOI/ Capitalization Rate = Property Value

300,000/.10 = $3,000,000

Now in 2018, by renovating the property you were able to raise rents $20 per unit.

Year 2:

NOI: $307,200

Cap rate: 10%

30 units

Annual NOI/ Capitalization Rate = Property Value

307,200/.10 = $3,072,000

As you can see, the value of the property increased $72,000 simply by raising rents by $20 per unit. 

The Bottom Line

When investing in residential real estate, investors are relying on outside forces, that are largely out of their control for appreciation. Whereas with commercial real estate, investors can force appreciation through raising the income and lowering expenses.


Babylon Property Group can assist those looking to diversify their portfolio by investing in real estate through Self-Directed IRAs and other sources of capital. For more information please contact us by phone at (631) 253-1609 or email at tcastelli@babylonpropertygroup.com.