I came across something last week that made me do a double-take.
A fellow investor had sent me an underwriting spreadsheet for a small multifamily property they were evaluating…but they were using a template designed for single family rentals.
And buried on row 13 was a line that simply said “Annual Appreciation” with a default assumption of 3%.
I literally laughed out loud.
Not because 3% is wrong (it’s a very reasonable assumption for residential real estate). But because I realized how long it’s been since I’ve thought about real estate that way.
In commercial real estate, we don’t sit around hoping for 3% appreciation. We create the appreciation ourselves.
The Single Family Equity Game
In residential real estate, you build equity through two main drivers.
First is market appreciation. Historically, this tracks inflation – so that 2-3% assumption makes sense. But here's the catch: it’s completely out of your control.
Sure, you can renovate a house. But even then, you’re still capped by what similar properties in the neighborhood have sold for recently. You can’t force a $200,000 house to be worth $400,000 just because you installed granite countertops.
Second is debt paydown. My friend Jason Hartman calls this “inflation induced debt destruction” – where your mortgage payment becomes smaller in real dollars over time, while tenants essentially pay down your principal balance for you.
Both of these are fine. But they’re largely passive. You’re along for the ride, hoping the market cooperates.
Taking Control
Commercial real estate works differently because it’s valued based on income production.
Here’s the basic formula to determine the value of a commercial real estate property:
Take a property’s Net Operating Income (all rents and other income minus all operating expenses except the mortgage)
Divide it by the market cap rate.
Quick example: A property producing $180,000 in NOI in a 6% cap rate market is worth $3 million ($180,000 ÷ 0.06 = $3,000,000).
This creates two levers for building equity. One you control, one you don’t.
Lever #1: Forced Appreciation
The controllable lever is NOI.
We specifically target properties where we can execute a value-add business plan to force NOI higher. Maybe we renovate units to command higher rents. Maybe we add amenities like a laundry facility. Maybe we find operational efficiencies to reduce expenses.
To illustrate, let’s say we switch landscaping vendors at a property and save $300 per month. That’s $3,600 annually added to NOI – not exactly life-changing money, right?
But…take that $3,600 NOI increase and divide by a 6% cap rate: $3,600 ÷ 0.06 = $60,000.
One phone call to change vendors just created $60,000 in equity.
That’s the power of forced appreciation in commercial real estate. Even small operational improvements can create massive value increases because of how the math works.
Lever #2: Cap Rate Compression (Market Forces)
The second lever is cap rate movement, which is the commercial equivalent of market appreciation.
When a market becomes more desirable, investors compete to buy there, which drives cap rates down. Lower cap rates mean higher values, even if NOI stays flat.
Using our same example: if market cap rates dropped from 6% to 5%, that $180,000 NOI property would jump from $3 million to $3.6 million in value. $600,000 in equity created from thin air, just because of how the market moved.
But here’s the thing – just like residential appreciation, cap rate compression is completely out of anyone’s control. It’s pure market forces.
The Critical Difference for Passive Investors
This brings me to the most important point for anyone evaluating syndication deals:
Pay close attention to which lever is driving the projected returns.
If most of the projected returns are coming from cap rates compressing (i.e., a lower cap rate at sale than at purchase), you’re essentially betting on the sponsor’s ability to predict future interest rates.
And that’s nearly impossible. The few people who are actually good at it aren’t syndicating value-add apartment buildings…they’re trading billions of dollars of bonds for hedge funds.
So what should you look for instead?
Deals where most of the value creation comes from executing proven operational improvements to increase NOI. That’s a business plan you can actually evaluate based on the sponsor’s track record.
The Bottom Line
Here’s what that spreadsheet with the 3% appreciation assumption really represents: the difference between hope and control.
In single family real estate, you’re largely at the mercy of market forces. You buy a property, make some improvements, and then wait for the neighborhood to appreciate around you. It’s a perfectly legitimate strategy – it’s just that your returns depend mostly on factors outside anyone’s control.
But commercial real estate, where value is tied directly to income, creates opportunities to intentionally and systematically increase a property’s worth. Small operational improvements compound into massive equity gains because of how the math maths.
That $60,000 of equity created by switching vendors? It’s not market luck…it’s a deal sponsor understanding how to pull the levers that actually matter.