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There’s a hidden secret in real estate: Single-family houses are evaluated based on market comparables (“comps”), while the real power of real estate lies in the profitability of commercial residential properties and knowing how to force equity.
One of the largest purchases in most Americans’ lives is their residence. Be sure your largest purchase has a positive net income.
First, it’s important to define a few terms. An asset is anything with a positive net income, and a liability is anything with a negative net income, or loss. Possibly even more important is what’s known as appreciation. Let’s look at how important (forced) appreciation truly can be in real estate.
Market Comparables In Residential Real Estate
Market comparables, otherwise known as “comps,” are the method by which nearly all single-family houses are evaluated and priced. This means when a house on the same street as yours with similar square footage, the same number of beds/baths and a similar construction year sells for a certain price, it will influence the price of your house. The single-family housing market typically takes the past 30-90 days of all comps and evaluates your house according to those prices, and not directly correlated to the upgrades you’ve installed.
The way to build equity in your home is called natural economic equity, meaning you wait over 30 years for the value of your house to appreciate. Natural economic equity can take a long time, and rarely can you force or accelerate this kind of appreciation.
Accelerating Appreciation In Apartments
Owning apartments is completely different for a variety of reasons, and this is the secret no one has told you. Apartments are not based upon comps. This means you do not have to wait for natural economic appreciation; you can force or accelerate this appreciation.
Apartments are based on rental income profitability. The controlling factor is called net operating income (NOI). The surface-level definition of NOI is, essentially, the total income minus expenses. One may increase their NOI by increasing income, lowering expenses or both. If you can increase your NOI, you have performed financial magic in two ways. First, you have increased your annual income, and secondly, you have forced the property value to increase. This is known as forced appreciation.
Forced (or accelerated) appreciation is the holy grail of real estate and the key difference between owning a house and owning an apartment complex. With apartment ownership, you may upgrade different amenities, appliances, structural integrity and overall aesthetics in order to increase the rent charged to tenants. When the rents are increased, the rental income directly affects the profitability of the building, and the property evaluation soars.
The golden secret here is that this type of appreciation is isolated from time. It could take six months or three years; it’s entirely dependent upon your ability to increase rents and maintain high occupancy. This is the value of profitability, and it’s illustrated by Robert Kiyosaki, who said that it’s “not so much how much money you make, but how much money you keep, how hard that money works for you, and how many generations you can keep it.”
Does Your House Pay You Like An Apartment Would?
Think back to the last month when your house produced more income than expenses. When did your house put more money into your bank account than it withdrew? Now consider this scenario with apartment ownership. When one of your renters now has brand-new granite countertops, tile floors, new appliances, and a new bathroom tub and sink, wouldn’t it be reasonable for them to pay a small increase in rent?
This leads to an increase of monthly and annual income, and more importantly, you also have forced appreciation. Rather than waiting for natural economic appreciation (like with a house), you have forced or accelerated the appreciation of the property by increasing the profitability of the building. When you force appreciation into an apartment complex, you may collect the property value increase through either refinancing or selling the property. This increase can be calculated with a very simple formula: Property value increase = (increase of NOI) / (capitalization rate).
Your House Is Limiting Your Financial Returns
The forced appreciation in apartment complexes is much more powerful than the natural economic equity over decades with single-family houses. During that period, don’t forget the difference in cash flow. Houses typically have a negative net income liability, whereas apartment complexes nearly always have a positive net income asset. This means you get paid regularly while you also can force appreciation in the short term, meaning six to 12 months (apartments) rather than 15 to 30 years (houses).
Peter Lynch says, “Know what you own, and know why you own it.” Do you own a home because society says it’s the “American Dream,” or because it’s the best financial decision for your family? Did you put a large payment down, and do you pay a monthly mortgage? Did you become responsible for mowing the lawn, repairing roof leaks and foundation issues, painting the exterior, fixing plumbing, making repairs, and paying yearly taxes and insurance so that your pride allows you to say you own it, even though it doesn’t produce any income?
What sounds like a dream to me is owning an apartment complex with hundreds of tenants, where rents, annual income and property value are increasing, therefore increasing appreciation. Your largest purchase should produce a positive net income, and it’s even better when you can force appreciation in the short term.
Remember what billionaire industrialist Andrew Carnegie is credited with saying: “Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”