For the last few years, most places in the country have been experiencing tremendous appreciation in the values of real estate. For the longest time I talked about how my house went up in value and, daily, I hear many others talk about how their homes have appreciated in value. Well, I have news for you, houses do not appreciate in value. Yes, you heard me correctly. Houses do not appreciate in value. You probably think I'm crazy, but let me explain. At the moment, I happen to live in one of the hottest real estate markets in the entire country. While there are many people out there clamoring for deals, I'm passing on deals. While others think the market is drying up, I'm still finding more then I want to deal with. How can this be, you ask?
The difference between myself and many other investors is that I understand appreciation. I realize that houses do not go up in value. It is the land that the home is sitting on that appreciates, not the house itself. The house itself actually goes down in value. It will maintain value if you keep it up, but otherwise it goes down in value and it costs money to maintain. So in a hot market, I'm looking for land. I don't care if there is a house on it or not, I'm looking for land. Land in good areas is like gold. A home will have a piece of land that someone will want. That person may or may not keep the house, but the land is the desired asset. Because land appreciates, it is a desired commodity in a hot market.
Here is an example of how appreciation of lands far outpaces the appreciation of a home:
A home in a $400,000 neighborhood that is appreciating at 10% per year goes up in value $40,000 per year. The lot next door may be worth $120,000, but in a year it also goes up $40,000, or 33% appreciation. Hence, the increase in value is due to the land, not the house which doesn't go up in value. It costs the same to build a home whether you pay $120,000 or $160,000 for the lot. Of course there may be some changes in the cost of lumber and materials, but this doesn't have much of an effect on the value of the home. The bottom line – the house on the property is always worth the same. You can replace it for essentially the same amount as you can two years from now. It's the land that goes up in value.
Once you understand this you will begin to look at deals differently. You'll see the small unattractive two bedroom rancher in a great neighborhood for the land that it sits on. You'll see the home with an extra lot beside it as two deals. You'll see vacant lots as gold mines and, yes, people go after land in hot markets like the gold rush of 1949.
Why does land appreciate? It's a matter of supply and demand. The areas of the country which are experiencing the highest rates of appreciation are for the most part saturated. There is very little land left to be developed and the populations are growing. In some cases there is no land left and smaller cheaper homes carry a premium because of the land they're sitting on. If you can pay market value for the “home,” you may actually be getting a “land” bargain. So when you pursue homes in very hot markets, sometimes you just have to look at the small home for what it can become. Don't pull comps for the home as it is, but for what it could be. A two bedroom rancher may be worth $350,000 on its best day, but a new four bedroom, 2.5 bath, colonial may be worth $700,000. If you could buy the two bedroom ranch for $300,000 or full market value, the land beneath may be worth more when you consider the new home that could be built on it.
So I encourage you all to open your eyes, understand appreciation, and look at deals in a different light.