What we talk about when we talk about appreciation

Have been doing some thinking about appreciation and how it affects our business.

First, what is appreciation? It is the tendency, over time, of the price of real estate (in Los Angeles, anyway) to increase.

A bit of clarification:

  • Obviously, there is no guarantee that real estate will increase in price over any particular time frame. Prices could fall tomorrow. But the general pattern, over many, many years, is for the price to increase; and
  • By increase, I mean “at a rate in excess of inflation”.

But appreciation in real estate is a very weird concept. After all, when you buy a property, part of what you’re buying is a physical structure which is, by definition, depreciating. If you don’t constantly repair your building it will degrade and, eventually collapse. Tax law recognizes this fact by allowing you to write off against your income 1/27.5 of the value of the structure each year you own it.

So, if the physical structure is always in the process of falling down, why do properties in LA tend to increase in price? If it’s not the structure, it must be the land, the other thing you’re purchasing when you buy a property.

That makes sense, right? The amount of residential land in LA is capped (both physically and, in terms of the number of people it can carry, by our insane zoning laws). And demand is growing, fueled by our amazing weather and strong, diverse economy.

Any time you have capped supply and increasing demand, you’re going to see price increases. And that is what fuels long term price increases in LA; it’s the land, not the structures.