Top reasons real estate increases in value

Real estate is probably the single largest investment in the portfolio of every family across the globe. Most middle-class families invest the maximum amount of money in their residential homes.In many parts of the world, this is reinforced by the fact that houses have exponentially risen in value. Stories of 50 times appreciation over a period of 20 years are not uncommon.

However, it is important to note that this is nowhere near an extraordinary rate of return. Even if a property has grown 50 times in 25 years, its annual rate of growth is less than 10 percent. It is lack of literacy about the magical effects of compounding that makes people blindly chase real estate.

The important point is that people look at historical data about real estate and expect the trend to continue. This means that they expect that over the next 50 years, the property prices will once again increase by a multiple of 100. This may or may not be true depending on the location.

When venturing into real estate, much like any other investment, the first thought that comes to a developer’s mind is the returns.

Land appreciates simply because it’s limited in supply. Consequently, as the population increases, so does the demand for land, driving its price up over time.

Owning land opens up the possibility of selling the first property and financing other investments such as developing another plot. As such, real asset becomes a greater source of financial security for an investor.

Appreciation in a property’s value can be caused by factors like inflation, increasing demand, and also improvements to the property.

INFRASTRUCTURE DEVELOPMENT

The availability of amenities is what makes an area attractive and desirable to potential buyers. People buying homes for their own use will be drawn by the development of new infrastructure such as hospitals, schools or other new real estate market drivers such as shopping malls, airports or increased public transport facilities in a particular area.

The price of land in these areas will keep increasing if the developments that can take up to ten years are continuously visible.

This also accounts for why serviced plots that have access to water, electricity and other amenities are priced higher than regular plots. Their availability impacts on the livability of the area.

Developers should be aware of the prospective commercial and government developments in the area that may impact land values.

NETWORK EXTERNALITIES

Once a location becomes popular with residents, it becomes a hotbed for several social activities. Hobby classes, restaurants, shopping malls, multiplexes etc. start operating in that area. This suits the lifestyle of many people and hence the properties in this residential market start trading at a premium. The more developed a location becomes, the more people want to live in it and prices continue to rise.

LAND USE CHANGES

With population growth and growth of urban areas, we’ve seen areas that have been previously marked for agricultural purposes being transformed to commercial and for residential purposes. Agricultural land is of generally lower value but when the utility changes, the value of the land increases.

INTEREST RATES AND GENERAL INFLATION

Interest rates also have a major impact on the real estate markets as changes can greatly influence a person's ability to purchase a residential property.

Low interest rates on mortgage loans translate to an excess of money in supply which can fuel the rate of home ownership as loans become cheaper.

Being a free market driven by the forces of demand and supply, the high demand will result in rising property prices.

The strength of the overall economy significantly impacts the real estate market as consumers’ ability to support housing prices largely depends on key factors like GDP, unemployment, and income growth.

Over time, inflation costs drive the price of building inputs like cement, steel and skill labour up, making construction projects more expensive. This makes properties more expensive. If the nominal price of the property is not increasing by two percent to three percent every year, it means that the homeowner in actually losing money in real terms. This is because the inflation is increasing whereas the price of the properties is not!

Developers factor in the additional costs due to general inflation and pass on the final cost to the buyer of the property.

LOCATION

Still on the demand and supply factor, people will want to live in places near their areas of work. In urban areas, residential areas which are located near places of work have a high demand among the working class which in turn drives the prices for re2ntals units.

Proximity to the workplace coupled with available amenities such as hospitals, schools and in areas where the cost of living is low are very attractive to the middle and lower class.

STRATEGIC INTERVENTIONS

In real estate, the physical structure actually depreciates in value over time in addition to incurring maintenance costs.

To cater for this, investors should consider how land appreciation can offset the depreciation of a home.

A developer can actively deploy some interventions to increase the value of the property. By observing market trends, an investor can adjust to cater for the demand in the housing sector and thus increase its value.

Modifications, for example adding an extra room or by modernising the structure to current market standards will help fetch more returns in the market.

Understanding the key factors that drive the real estate market is essential to performing a comprehensive evaluation of a potential investment in the sector.

Mr Muriithi is the Head of Sales and Marketing Centum Real Estate