The Difference Between Inflation and Appreciation

These two terms are often used interchangeably when discussing real estate investments. Though they are clearly related, I use them to refer to distinct and separate concepts.

What is inflation?

Inflation is the general increase in the price of goods and services. To measure it, the government maintains a list of the costs of specific items that are meant to be representative of all consumer costs. That list is the Consumer Price Index (CPI) and its annual rate of change is the inflation rate. When the government publishes an inflation rate of 3% it is indicating the cost of the goods and services included in the CPI increased by 3% year over year. That published rate is a useful approximation for the increase in prices that we are experiencing across the whole economy.

What is appreciation?

But appreciation is best understood as an increase in the value of an asset beyond inflation. As we know, the value of real estate tends to go up over time. Some part of that increase is simple inflation?the cost of everything tends to go up over time. Land in growing areas, however, tends to increase beyond the rate of inflation. That is, it doesn?t just inflate, it appreciates. Appreciation is an increase in value beyond the inflated value of other goods and services.

Growth in real estate

The cause of appreciation in land is an increase in the demand for it, typically as population densities and traffic patterns change. As traffic increases on a given thoroughfare or intersection, the commercial value of the land accessible to that traffic appreciates. As an area becomes more densely populated the demand for housing rises, increasing values beyond the rate of inflation.

Appreciation in the Phoenix Metro area

The Phoenix metro area continues to expand into new areas as its population grows. Newcomers to the valley seek affordable housing, which creates development pressure in outlying areas. Acreage that was once valued as farmland suddenly becomes much more valuable to builders. A corner that was once the intersection of two dirt roads becomes a demanded location for a convenience store or gas station. The land appreciates, often radically.

The objective of a land investor is to strategically exploit the changing traffic patterns and population densities which increase the value of well located land. Investors want to buy land assets on which demand is increasing. That is, they want assets that will appreciate, not just inflate. Successful land investors will be those that buy land that will have a substantial increase in future demand, raising values beyond the rate of inflation.

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