If you buy, hold, and sell real estate for trade or investment, you already know that returns are an important factor in determining an effective investment strategy. Also important? Knowing your asset’s capital appreciation and how to calculate it. Fortunately, you don’t need to be a math whiz to determine the numbers. You only need to know the basic formulas.
What it Is
But before delving into the actual computations, let’s see what it is. Simply defined, capital appreciation represents the increase in your investment’s market price. Specifically, it’s the difference between what you paid for that asset and what you might be able to sell it for.
Along with the above, here are other important definitions connected to capital appreciation:
Cost basis. When it comes to commercial real estate held for investment purposes, your basis is defined as the original purchase price or “cost” of the investment property. Also included in the basis are any out-of-pocket expenses or closing costs generated when you bought the real estate asset. Broker’s commission? It’s included in the cost basis. The amount paid for title insurance and loan fees? Same thing.
Market value. Market value is the sales price that your property would attract if you were to put it on the open market under fair sale conditions. A market value estimate could be determined through estimated development costs, comparable property sales (also known as “comps”), or even a discounted cash flow analysis.
As a final word, capital appreciation differs from income and total return. Income involves monies paid out from owning an asset (such as interest payments). Meanwhile, your asset’s total return is defined as a combination of capital appreciation and income.
How to Calculate
With the above in mind, you’re one step closer to calculating the capital appreciation on your real estate assets. There are two ways in which you can do this: either by dollar amount or as a percentage.
Calculating a capital appreciation dollar amount involves subtracting the real estate’s cost basis from its market value. If, for example, your real estate’s cost basis is $100,000 and the market value is $120,000, then your capital appreciation formula would be:
$120,000 – $100,000 = $20,000
The capital appreciation is $20,000.
Under certain situations, you might find a percentage gain or loss more effective. When calculating a capital appreciation percentage gain or loss, you take the dollar amount of your capital appreciation, divide it by your cost basis, then multiply it by 100.
In the above example, in which your cost basis is $100,000 and market value is $120,000, the dollar amount of your capital appreciation is $20,000. Here’s how to calculate the percentage gain or loss:
$20,000/$100,000 x 100 = 20%
Why It’s Important
Now that you know what capital appreciation is on your real estate and how to calculate it, the next question you might have is: “why should I bother?” The answer? Because it’s a good idea to know how well your investment is performing. Knowing your real estate asset holdings’ dollar or percentage capital appreciation is essential for ensuring a continued effective investment strategy.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. All real estate investments have the potential to lose value during the life of the investment.