APPRECIATION POTENTIALA tight market is one in which the demand for the particular type of property is greater than the supply. The tighter the market is, the greater the appreciation potential of a property, at least in the short and medium term. Here we emphasize that the time dimension of such appreciation is short-term or medium term, because historically real estate supply has shown to overreact to property price increases. So as property prices start registering some strong increases due to strong demand, developers and investors alike rush into the market with many new projects. The result is overbuilding, which brings excess supply in the market, which eventually reverses the rising path of property prices to a downward spiral. So the key steps to evaluating the appreciation potential of a property are the following: 1. Get data on the current state of the market and especially the local vacancy rate and the broader market vacancy rate. A low local vacancy rate in a neighborhood or sub-market within a broader market that has a very high vacancy rate should be viewed with extreme caution when trying to assess the appreciation potential of a property. For example, a very low apartment vacancy rate in a sub-market within the Los Angeles area should be viewed with caution if the overall apartment vacancy rate for the latter is quite high.
2. Get data on the building permits that were issued in the year of analysis, as well as in previous years, and use them as basis in order to predict how much new supply of product similar to the property under consideration will be entering the market in the next 2-3 years. This is part of the calculation of the available supply over the period of analysis, which needs to take also into account the percentage of the stock that is vacant at the time of analysis. 3. Obtain competent forecasts of the demand for the particular property type under consideration and the urban area within which it competes and the sub-market within which it is located, if possible 4. Calculate the difference between market demand and available market supply in order to evaluate which of the two will prevail. In carrying out this calculation, one should deduct from the estimated available supply and a percentage of the total stock that represents the “natural vacancy rate”, which is the vacant stock required for the normal operation of the market in order to accommodate the search processes of both buyers/tenants and sellers/landlords. Also it is absolutely important to make sure the the demand forecast and estimate of the available supply and the "natural vacant stock" refer to the same geographic area. If the result from the above calculation is in favor of demand, then the property is very likely to experience appreciation. The greater the difference of expected demand from available supply, the higher the appreciation potential of the property. Of course, here we assume that there are no property-specific factors or dynamics that will push the value of the property down. The appreciation potential of a property due to market forces may be neutralized or even reversed by negative influences and/or dynamics due to property-specific or location-specific factors, such as adverse developments in the neighborhood of the property that cause serious nuisances, changes in the tax rates, school quality, etc.
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