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Real Estate Investors: What If Property Values Don’t Increase?

by Brandon Turner on August 26, 2012 · 12 comments

  
real estate appreciation

Property values always go up.

Or at least that’s what people believed.

For years, values have consistently climbed higher and higher at an average rate of around 5% per year. Real estate investors rely heavily on price appreciation to maximize their investment for the future. I know that I personally hope my properties will continue to climb in value for many years and I’ll be able to retire before I hit thirty-five.

But what if values don’t increase?

It’s a question worth asking. When you buy a property, you have a lot of control. You can decide many things, such as:

  • Where To Buy
  • How Much To Pay
  • How Much To Improve The Property

However, you do not have control over the future value. While we can hope that property values will continue to rise – there is no guarantee.

So what happens if property prices stay level? What if they never improve? What if they decline? How does that affect your investing? I want to look quickly at three aspects related to this scenario and explain why real estate investing does not, and should not, simply rely on appreciation for success.

3 Reasons Why Real Estate Investors Should Not Rely Only on Appreciation:

1.) Mortgage Still Being Paid Off

Even if prices never climbed any higher, unless you purchase a property with an interest-only loan, the mortgage balance is still decreasing each and every month. This means next month you will owe less than today, and today you owe less than last month. If you amortized the loan over a thirty-year period, then in thirty years you will owe nothing. Even if your property hasn’t doubled or tripled in value by then you still have significant equity and cashflow.

This is a good reason why, depending on your investment strategy, constantly refinancing and pulling out equity may not be a wise decision. I know there are math nerds out there that will tell me how if I pull out equity at 5% and make a 10% return-on-investment on that money I will be richer. I understand the math (after all, I was president of my high school Math Club…)

The problem is, as Dave Ramsey likes to say, 100% of all foreclosures last year happened to people with mortgages. Don’t get me wrong – I’m not suggesting you shouldn’t finance your properties (though, paying all cash for them is not a bad way to invest if you have the funds). I am, however, encouraging you to look at the long term picture and think of the end game. If prices never climbed, in thirty (or fewer) years you will own a piece of property that is free and clear but producing income.

2.) More Incentive To Make Your Money At The Purchase

You’ve heard the quote, “A rising tide lifts all ships.” This is what appreciation is – a rising tide. It’s also an excuse to invest lazily, assuming the market will bail you out. In the frenzy which was the real estate market in the mid 2000s there were “gurus” out there advocating spending ANY amount to buy a property, because the market would eventually catch up. Thousands of investors lost everything because of this mentality when the market didn’t just stop climbing – it fell (and fell hard).

Warren Buffet is famous for saying, “Only when the tide goes out do you discover who’s been swimming naked.”

This is what happens when investors rely on appreciation to save them rather than relying on cold hard facts and figures. When I invest, I buy property with the assumption that it will NEVER climb in value. Never. Appreciation is the icing on the cake, not the freight train to freedom. If my property was suddenly worth double what I paid, I would be ecstatic. However, if it stayed the same or even decreased – it doesn’t change the fact that I bought correctly and the cashflow is still proving income day in and day out. This is the story behind my favorite property, the Kurt Cobain duplex.

Don’t make the same mistake as the thousands of investors who followed the gurus and lazily invested in anything. Stick to strict buying standards and make your money when you buy – not when you sell.

3.) You Can Always Find Ways to Force Appreciation

The “market” is NOT your property. Each property is different and comes with a different set of challenges and opportunities. Don’t assume that just because “the market” isn’t improving that your own property can’t increase in value either. There are hundreds of ways to maximize your property and increase the value without relying on real estate appreciation. I don’t need to go into extreme depth to cover this, as I discussed specific ways to easily increase property values in my previous article Ten Quick and Easy Ways to Increase Your Property’s Value. It’s enough to know that appreciation can, and should, be forced.

Donald Trump said, “ If you plan for the worst – if you can live with the worst – the good will always take care of itself. ” It’s with these words that I want to close. Appreciation should be an added benefit, not the end game. Invest like values will not increase and you’ll find yourself in the best case scenario no matter what the market does. Even if value does not increase, and I may not be able to retire by thirty-five (and what would I do then but continue my passion of investing in real estate?), I still am able to ensure success and minimize the risk down to almost none. To me, that is more important than the hope that prices will rise forever.

What do you think? Will the market turn around? And does it even matter? Comment below!

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{ 12 comments… read them below or add one }

Nancy P-Y August 26, 2012 at 9:29 am

I agree with you totally, Brandon. I have always tried to buy properties “right” as well, and not rely on appreciation to secure my profit. I have met other investors that did not follow this principle, and they ended up losing several properties a few years ago.
Just curious about something, Brandon. What on earth would you be retiring from at 35? You don’t “work” now, do you? Just kiddin’ ; )

Reply

Brandon Turner August 27, 2012 at 5:26 pm

Nah, I watch my “Stories” all day and eat. It’s a good life ;)

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Jim Pratt August 26, 2012 at 11:17 am

When I first started out, had a few simple rules: dog of the the block, 3 bedroom in a good area, buy at 30-50 cents on the dollar, add value and get at least $100 a month positive cash flow. It took ten years but, I was able to retire at 42, 23 years ago:) I didn’t plan on anything except the monthly cash flow from $100 per month when started to now at $360 (avg,) per property. Values of my proprties have double or triple over time, rents tripled.
P.S. You can’t really retire, but with property managers, one can relax more.

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Brandon Turner August 27, 2012 at 5:27 pm

Those are generally the same rules I have, Jim. I’m glad to see it worked out for you! It’s great to see how real estate helps people who have been in it for a while! Thanks for the comment!

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Mike August 27, 2012 at 8:25 am

Good points as always Brandon. Love that Buffet line. Lol.

I just think you have to ignore market appreciation and create your own appreciation with solid buy fundamentals, use the 70% rule, sticking to your rehab budget and nor overinflating your ARV. If the market rises, great. If it falls, youre insured on the downside as well.

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Brandon Turner August 27, 2012 at 5:28 pm

That Buffet line makes me laugh every time! Thanks Mike!

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Gayatri S August 28, 2012 at 1:27 am

Appreciation is probably a multifaceted concept having countless undefined dimensions to it. To some a significant hike in the property price at the time of sale may be considered as appreciation. Whereas for some a tenfold increase in the price will be nothing more than a ‘minor’ appreciation. How we perceive appreciation tends to differ from person-to-person. With the onset of the economic slowdown, appreciation in the property prices may occupy a backseat! The real estate bubble may burst causing a steep fall in the property prices. Appreciation is not a guarantee then!
So whatever be the market trends, purchasing a property merely for appreciation won’t help in the long run. At the end of the day having a property of your own, as a firm investment, outweighs everything else including appreciation.

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Brandon Turner September 6, 2012 at 9:16 pm

Agreed Gayatri! Thanks for the comment!

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Greg August 28, 2012 at 2:35 pm

There are some properties that have been foreclosed because the person didn’t pay their taxes. In fact, on that TV show “Extreme Makeover: Home Edition”, some of those people were foreclosed, because the refurbished homes were reappraised with a much higher value, and even with no mortgage, the people couldn’t afford the taxes.

While you can say 100% of last years mortgages were foreclosed, something like 99% of all mortgages are current, so I tend to dismiss that soundbite out of hand. Why do you think most people have more equity built up in their home than in their retirement savings? Equity in your home doesn’t earn anything.

I agree with your plan to assume no appreciation and no rent increases, if/when either happens, it is icing on the cake. Pouring any/all extra rent into knocking out one mortgage at a time seems like a good strategy to me.

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Brandon Turner September 6, 2012 at 9:17 pm

I also like that strategy of pouring cashflow back into killing those mortgages, though I don’t do a lot of that yet! Someday!

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Ziv Magen September 4, 2012 at 3:08 am

Couldn’t agree more. Cashflow is king. Everything else is icing on the cake. Well written piece.

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Brandon Turner September 6, 2012 at 9:18 pm

Thanks Ziv! And I love cake, with or without icing :)

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