Capital Appreciation: Evaluating Performance of Real Estate Investments
If you are new to the world of real estate investing, it won’t take long to come across a lot of different industry specific terms such as capital appreciation. This term may seem confusing and daunting at first, but the good news is we are here to explain what it is and how to implement it in your investments.
What is Capital Appreciation?
By nature, the market value of investments changes over time with prevailing market conditions. When the value of your investment increases, there is appreciation, and when the value of your investment decreases, there is depreciation. Simply defined, capital appreciation is when the market price of real estate rises. It is the difference between the initial purchase price and the eventual selling price of an investment. It is used to determine the performance of real estate investment. It happens when the price of a stock, the property worth of a home, or the value of your real estate grows. For example, if you pay $1,000 for a stock investment and its price increases to $1,500, you could say that the investment has appreciated by $500.
Here are two important definitions that are connected to capital appreciation:
Cost Basis: Cost basis is the context of commercial real estate. It’s the original purchase price of investment property and any out-of-pocket expenses or closing costs related. Consider this scenario: you bought a rental property for $500,000 which is now worth $550,000. Sounds like a $50,000 gain, right? Not exactly. Keep in mind, during the closing you might have paid $10,000 for title insurance and another $10,000 in loan fees. This means your initial basis in property is $520,000 and your gain is $30,000.
Market Value: Market value is the sales price of a property in the market if you were to put it on the open market. Market value is usually determined by the market through a combination of comparable sales, projected rebuild costs, and the income approach. Generally commercial real estate, including large multifamily investments, are valued with an emphasis on the income approach, via the market capitalization rate derived from the Net Operating Income (NOI) of the asset.
Capital appreciation is different from income and total return. Income is the money that is paid out from owning an asset, such as operating expenses and debt service. Your total asset return is defined as a combination of capital appreciation and ongoing cash flow.
How Commercial Appreciation is Calculated
There are two ways to go about calculating capital appreciation: either by dollar amount or as a percentage.
Dollar Amount
Calculating a capital appreciation dollar amount involves subtracting the cost basis from its market value. For example, let’s say your real estate’s cost basis is $200,000 and the market value is $230,000, the formula for your capital appreciation would be:
Cost Basis - Market Value = Capital Appreciation
$230,000 - $200,000 = $30,000
The capital appreciation is $30,000.
Percentage
When calculating a capital appreciation percentage gain or loss, take the dollar amount of your capital appreciation, then divide it by your cost basis, and then multiply by 100.
Let’s take the example from above. Your basis is $200,000, your market value is $230,000, and the dollar amount of your capital appreciation is $30,000. Here is the formula:
(Capital Appreciation/Cost Basis) x 100%
($30,000/$200,000) x 100% = 15%
The Importance of Capital Appreciation
Capital appreciation is important for you as an investor to be aware of and fully understand. Every commercial real estate investor needs to consider capital appreciation when planning their investment property strategy to get the most out of their investment. Capital appreciation provides one of the best ways to make a large return on their investment.
CF Capital is here to support you in achieving your real estate investment goals. We are a national real estate investment firm that focuses on acquiring and operating multifamily assets that provide stable cash flow, capital appreciation, and a margin of safety. Contact us today and learn about our passive investment opportunities!
