Many first-time home buyers believe that the physical characteristics of a home will lead to a higher property value. But in reality, the physical structure of a property tends to depreciate over time, while the land on which it sits generally appreciates in value. Although this distinction may seem trivial, understanding how potential land values influence property returns allows investors to make better decisions.
Simply put, land appreciates because it has a limited supply. After all, no one is producing more land. Consequently, as the population increases, so does the demand for land, increasing its price over time. Therefore, investors should consider how land appreciation can offset the depreciation of a home, which requires an injection of capital to maintain, as it ages. The Internal Revenue Service (IRS) even recognizes this inevitability by allowing depreciation of a physical structure to reduce the tax liability of a business or investment.
The degree of physical depreciation and / or obsolescence varies from property to property, but if left alone, properties continue to depreciate until they no longer add any value to the land. Some owners even bulldoze physical structures to maximize the value of their parcels.
- Many first-time home buyers believe that the physical characteristics of a home will lead to a higher property value. But in reality, the physical structure of a property tends to depreciate over time, while the land on which it sits generally appreciates in value.
- Understanding how potential land values influence property returns allows investors to make better decisions.
- Land is appreciated because its supply is limited; consequently, as the population increases, so does the demand for land, causing its price to rise over time.
The 4 main things that determine the value of a home
Once an investor understands the impact of land value on total appreciation, the time-honored real estate mantra of “location, location, location” takes on even greater significance. Smart home buyers overlook the physical attributes of a home and focus on its physical site, keeping the following elements in mind:
Locations within neighborhoods will affect the value of the land.
Not all points within a given area are considered equal. A home next to a cul-de-sac is often in higher demand than a home located near a busy road because the former has less traffic and is safer for young children. Additionally, most upper- and middle-class single-family neighborhoods have new building limits that are set when developers purchase most of the land available to build the subdivisions. Consequently, most neighborhoods develop their own social, cultural, and demographic characteristics that impact the demand for housing.
The average age of the neighbors can provide clues for appreciation.
New home buyers with young children often avoid locations with older homeowners who will not provide playmates for their little ones. Additionally, specific public schools can influence the demand for housing in particular school districts.
Future development can change the value of a property for better or for worse.
Homeowners should not only be aware of current local amenities, but they should also be aware of future commercial and municipal developments in the area, such as plans for new schools, hospitals, and public infrastructure, which may affect the value of the land.
Investors in single-family properties should also consider possible condo development in their neighborhoods. Because condo complexes can contain multiple units on small parcels of land, increasing supply could lower prices for all. zone homes.
The bottom line
Successful real estate investors look beyond the stylistic attributes of potential home purchases and focus on a property’s potential for land appreciation. This requires overlooking the most attractive homes in a destination location and focusing on those that provide opportunities for improvement, which can increase the value of the land. Investors can track the appreciation by visiting the Federal Housing Finance Agency (FHFA). (For related reading, see “6 Things You Think Add Value To Your Home But They Don’t”)