Capital growth. What is it? What causes it?
What is it?
Captial growth essentially means “increase in value.” So, for a property to achieve capital growth, it must be worth more today than it was yesterday. Or, it’s worth more today than it was ten years ago. Bottom line, the asset increased in value. Therefore, if you sold it, you’d make money; you’d make a profit.
What Causes it?
Now, the tough question, what causes it?
According to Jan Somers, author of the book, Building Wealth Through Investment Property
Let’s look at each one.
Inflation
Does a cup of coffee at the local shop cost more today than it did 10 years ago? You bet!
Does it cost more to build a house today than it did 10 years ago?
Yes!
Welcome to the world of inflation.
Why does it cost more? Why doesn’t it cost less? Why should prices tend upwards? Why couldn’t they tend downwards just as well?
Not really sure on all counts. But, if you want a more in-depth look at inflation then read my article, What causes inflation?
But, can we agree that over time prices tend to rise? This includes land, building materials and labor costs. All things required to build a home.
So, the end result is that housing costs tend to rise; hence inflation is a contributor to captial growth.
Land Scarcity
Now this one makes me chuckle a bit. You see, here in Australia, land is plentiful. So, how does land scarcity play a role in capital growth?
Well, things are never quite that simple.
Do you want to build your house on a hill overlooking Syndey Harbor? Too late, someone beat you to it! You’ll have to buy it off them. Do think it will be cheap?
What if I want to build a house just outside Alice Springs. Can I just order the building materials and start building?
No way.
I’ve got to develop the land and then receive a title. All this takes approval. And, lots of money. And, lots of patience to untangle the government red tape.
So, I hope this gives you some idea of the concept of land scarcity. Yes, there’s plenty of land. But, virtually all of the most desired spots are already taken and opening up new spots takes time and money; lots of time and lots of money!
Of course, this “land scarcity” contributes to capital growth of existing homes. As the cost of developing new building lots rises, so does the price of existing homes. As the demand for “prime” property locations rises, so does the price of existing homes in these prime areas.
Adding Value
According to Jan, there are two ways to add value to a home; renovations and rezoning.
Renovations
If you own a 3 bedroom house and add a 4th bedroom, have you added value to the home?
If you have a carport and turn it into a garage, have you added value?
What if you modernize your kitchen?
These are examples of value adding renovations.
Do you think people will tend to pay more money for a house with more value adding features?
Value adding renovations contribute to capital growth; people will tend to pay more for these type of upgrades.
Rezoning
What if you go to your local planning board and get approval to subdivide your block of land?
What if – surprise, surprise – they approve it? And, your luck just keeps getting better when they give you permission to build a duplex on the new subdivided block?
Do you think your block of land is more valuable now that you’ve got permission to subdivide and build a duplex?
You bet. You just manufactured capital growth.
How excited would you be to sell one half of the subdivided block for more than you paid for the entire block?
So, rezoning land for a higher value use is another way to create capital growth.
Passive and Active
Notice the first two factors – inflation and land scarcity – are passive. You don’t really have any control over these areas.
But, the third factor is different. Adding value is an area where you can roll up your sleeves and make it happen. You have to opportunity to inject capital growth; manufacture it; create it.
But, be careful. Make sure you add value and not subtract it. For instance, I’d be a bit concerned if someone “upgraded” a 4 bedroom house down to a 3 bedroom house. Is that adding value?
“Oh, but now the bedrooms are bigger!” Comes the reply.
But, will people pay more? Will they see this as adding value?
So, you’ve got to be careful when “upgrading.”
Where’s the Capital Growth Opportunity?
I’m glad I reviewed these critical capital growth factors. Now, when I’m out looking for my next rental property they’ll be in the front of my mind. As I’m walking through each property I’ll be asking myself, “Where is the capital growth opportunity here?”