A Few Basic Factors Influencing Property Prices

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Many first-time homeowners and experienced real estate investors seem to focus on the functionality and style of their proposed purchases, expecting these characteristics to lead to increased property value. Many fail to remember the slogan of the real estate industry - "location, location, location" - when trying to find the property that will lead to the greatest investment performance.

The reality is that the physical structure actually depreciates over time. It is the land underneath the structure that appreciates in value. This is a significant distinction, considering that the purchase of a home is the single greatest investment that most retail investors will make in their lifetimes. Failing to look at one's home as an investment and understand the drivers of value, or concentrating on functionality and accommodation, can limit the property's overall performance and opportunities to maximize wealth.

Land as an Appreciating Asset

Making the distinction between the improved portion of a property and the land on which it sits may seem trivial. But it is not until the real estate investor focuses on these differences that it becomes easier to find more efficient investments that provide the highest return for the amount of risk or capital invested. Because property prices are a function of local supply and demand, the appearance, functionality and maintenance of the physical structure will certainly impact value, but these factors have less impact than one may think.

The reason that land is an appreciating asset is a simple one. It is in limited supply, and no one is producing any more. The demand for land is constantly growing as the population increases, and since its supply is limited, its price must increase over time. Unless something happens to limit demand for a given area or make it unusable, the grounds should be expected to increase in value over time.

The question is how much the land will appreciate and how much the improvements will enhance or degrade overall value. The physical structure on a property is a depreciating asset. As it ages, it requires capital infusions for maintenance, updating to stem functional obsolescence and, depending on its design, updating to prevent it from falling out of style.

The degree of depreciation or physical obsolescence will be specific to each property, but it is fair to say that if left alone, a property will continue to lose value until it no longer adds value to the land, or even reduces its value.

Once an investor understands the impact of land value on total appreciation, the market's mantra of "location, location, location" makes more sense. The implication is that home buyers have to look past the physical attributes of the home and focus how its location in the market will affect overall return. This is extremely difficult for home buyers who expect to live in their homes for an extended period of time. However, even the most lackluster of purchases can be improved over time and create significant wealth if located in an area of high demand. The following are some considerations for new home buyers to consider:

Smaller or less attractive homes can provide greater investment returns.

To understand this point, envision two functionally sound houses on equal land parcels in the same neighborhood, one valued near the maximum for houses in that neighborhood and another trading at half that price. Since local supply and demand factors drive land values, houses in a neighborhood tend to appreciate by approximately the same amount per year. If the more expensive house appreciates by 10% (not including any specific improvement or capital projects), this would be equivalent to a 20% return for the other - a much more efficient use of investment capital.

Locations within neighborhoods will affect land values.

Locations, such as cul-de-sacs, due their constraint on traffic and implied safety for children, are usually in higher demand than houses on more frequently used roadways.

The average age of neighbors can provide clues to appreciation.

Many investors do not consider this when selecting locations. New home buyers with small children will often avoid locations with older homeowners that will not provide playmates for their children. Also, most homeowners are aware of the influence that specific public schools have on the demand for homes in that particular school district. Since homes in the area are not homogeneous, the appreciation is all due to location and the value of land.

Future development can change your property's value for better or for worse.

Homeowners must be cognizant not only of the present state of local amenities, but also the future prospects for commercial and governmental development in the area. Government plans concerning schools, hospitals, traffic patterns and other public infrastructure will have as much influence on land values as present and future development of commercial amenities in a particular locale.

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