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Importance of Real Estate Appreciation

Posted By: Robert Judy In: Making and Saving Money
Date: Wed, Aug 10th 2016 11:59 am

Appreciation can be the determining factor when deciding whether to buy a house or rent. A $235k home becomes worth $485k at 3% appreciation after 30 years, but it becomes worth a whopping $649k at 4% appreciation. One percentage point makes quite a difference! Another reason the appreciation rate is important is you might now want to be tied down for 30 years. If the appreciation rate is high enough, the extra value of the house in a few years will offset the upfront costs of buying.  If the appreciation rate is too low then it won't.

The best thing about appreciation is the fact that if the appreciation rate is high enough, you will get to live for free! Or even better, you will actually get paid to live in a house. With this being said, it is important to try and get a grasp on the appreciation rate of an area you are thinking about moving to.

Determining the expected appreciation rate of a real estate can be difficult for many reasons. Trying to predict the rate of appreciation can be like trying to predict anything, you just don’t know what the future holds. But when you think about it, it seems that long-term appreciation rates would have to be pretty close to the general rate of inflation.  Because if appreciation were much higher than inflation, then it wouldn't be too long before no one could afford to buy a house! If workers make 3% more per year on average, but the price of homes goes up by 6% per year, then pretty soon homes become widely unaffordable.

U.S. census data tells us that the price of new homes increased by 5.4% annually from 1963 to 2008, on average. First, let's account for the fact that the average new home size exploded from 983 s.f. to 2349 s.f. from 1950-2004, or about 1.6% per year on average. So a big chunk of the increase isn't inflation, it's that bigger homes cost more money. Once we factor that in, the price of new homes per square foot went up by only 4.2% annually from 1963 to 2008. Now let's compare that rate to the general rate of inflation, which was 4.4% for the same period. As predicted earlier, the rate of real estate inflation and the general rate of inflation are almost identical.

When you are looking at renting vs buying in a certain area, take into consideration the appreciation value of your specific real estate property. A good rule of thumb is to set the rate of appreciation equal to the inflation rate. As I said earlier, an appreciation rate of 3% compared to an appreciation rate of 4% over time could be the difference in hundreds of thousands of dollars.