How my 5-7 year plan went to .... Why not to count on appreciation. Response to podcast 103

82 Replies

I was just listening to Elizabeth Colegrove on podcast 103.  She is obviously a very bright investor who is currently doing what I call the W.E.B. Griffin RE investing strategy.  Basically, buying a house at every duty station and then renting it out when you PCS (move).   She is doing more than that too. 

Anyway, her plan is to buy new or newer properties that she rehabs then hold on to those properties for 5-7 years. At that point she will sell and 1031 into a new property.  This is an outstanding plan provided that there is appreciation in her houses.  

I had a very similar plan back in 2004.  I started buying properties with zero or little down and usually negative cash flow (that was tax advantageous for me).  With the tax advantages it came fairly close to breaking even or maybe I was putting in $100 per month. I was counting on 3-5% appreciation per year.  After five years a house I paid $160K for all-in would presumably be worth about $200K.  I'd also would have paid off $10k on the mortgage. (That assumes I got a 100% mortgage like Elizabeth, instead I  got an 80-20 mortgage which is worse, but I'm trying to keep this simple). 

The numbers were expected to look something like this.  $200K less 10% selling costs (I didn't realize I'd need to rehab before selling  so that cost wasn't factored in), netting me $180K, less the $100 net negative cash flow after taxes or $6K, plus the $10K I paid towards the mortgage equating to $24K in gains.  That sure seemed like a fairly simple plan for me a newbie investor at the time.

But then the recession hit.  Fast forward ten years, the house I paid $160K for is now worth a grand total of $130K on a good day.  My mortgage is down to about $137K,  so after 10 years my house is underwater by $7K.

Also that $100 I was losing every month became something like $200 because rents fell right along with house prices.  And as my property has begun to age and need new paint and carpet, I'm losing at least another $100 a month due to capex.   So instead of $25K gained in five years, I'm down something well over $20K in ten years.  

I sincerely hope that her plans works out for her, much better than mine did! This is not meant to be a post aimed at anyway towards knocking Elizabeth, it is meant to be a warning to investors not to count on appreciation.  GOD I hope this thread doesn't turn into another J and Bob show.  

@Cal C.  Thanks for your honesty.  It is easy to talk about successes, not so much about failures--especially big, business-ending failures.  Kudos to you for still being in the game.

@Cal C.  Yep...2003.  I remember it well....well, I remember it. I too felt the wrath of those years (I was lucky...I tell people smart, but...) when the appreciation I was counting from the previous years went...somewhere.  If anyone else can find it, please let me know.

Since then, I've looked at appreciation as the "wrapping paper" on my gift...the gift, being cash flow.  If it's there when I need it, great.  If it isn't there when I would normally need it, since I'm not counting on it, I'm not going to worry about it.

Although, @Elizabeth Colegrove only looks at a 5-7 year period, so I trust her timetable is probably workable. Longer than 7 years, and I think you run into that "cycle" and the risk of a re enactment of 2003 Space Odyssey for REI. I do like her system though.

I just finished listening to that podcast today too.  I was thinking the same thing when she mentioned appreciation.  In a good economy, appreciation is great but what happens if it starts to go downward?  Or if something undesirable is moving close to the neighborhood?

When I run my analysis, I make sure my expenses are covered, my cashflow is acceptable, and COC return is close or above what I'm trying to get.

I've always thought of appreciation as an extra bonus to my investing.

@Cal C.   - thank you for honestly sharing.  We have two homes in our portfolio that are still underwater from those days as well.  It is way more common than many people think, and it can easily happen in today's market as well.    

Medium labelJonna Weber, Jonna Weber Real Estate | [email protected] | 208‑608‑4884 | http://www.jonnaweber.com | ID Agent # SP41257 | Podcast Guest on Show #80

I consider "Appreciation" sorta like intimacy after the kids come. It's nice, we hope for it, and sometimes it happens! Sometimes...

@Cal C. thank you for sharing. I am just getting started in REI it is good to here things to be cautious about.

I listened to the @Elizabeth Colegrove podcast as well. My take away was that she is using high leverage to buy units significantly below market value (i.e. the short sells she talked about). That would appear to give her a buffer in the event of another downturn.

Out of curiosity was the house purchased in 2004 for 160K at or below the 2004 market level when purchased?

Again I am just starting out in this and trying to learn as much as I can. My take on the whole thing could be way off base.

@Joseph Ball  I just saw your post. That is too funny and way to true.... Thanks for the laugh!!

I think her plan is a solid one but my big fear would be what effect the closing of one of the military bases would have on property values. In my area the Air force built way more housing that it turned out they needed and now they allow civilians to rent on base.

I think one of my neighbors was doing the house trade-up thing.  They got stuck in 2008-09.

@Joseph Ball  "I consider "Appreciation" sorta like intimacy after the kids come. It's nice, we hope for it, and sometimes it happens! Sometimes..."

Gotta love it when a guy named Joseph has a sense of humor.  I'm going to use this, if you don't mind.  LOL.

appreciation is something I appreciate. I don't count on it though

Originally posted by @Jeffery Griggs :

@Cal C. thank you for sharing. I am just getting started in REI it is good to here things to be cautious about.

I listened to the @Elizabeth Colegrove podcast as well. My take away was that she is using high leverage to buy units significantly below market value (i.e. the short sells she talked about). That would appear to give her a buffer in the event of another downturn.

Out of curiosity was the house purchased in 2004 for 160K at or below the 2004 market level when purchased?

Again I am just starting out in this and trying to learn as much as I can. My take on the whole thing could be way off base.

Unlike Elizabeth I didn't get it below market. There wasn't much you could buy below market back then when buying off of the MLS like I was. I did buy a brand new home.

But lets suppose for a second that I bought if 15% under market I'd still be losing on it or nearly so.  But that is only because Atlanta has come back considerably the last two years.  In 2011 and 2012, I would have been significantly underwater even if I would have bought it 15% under market.  

I'd have been a heck of a lot better off simply putting my money in the bank.  

Originally posted by @J Scott:

Cal - You should have kept all those houses we were buying in 2010-2012! 

Me too...  :-(

 Umm, I effectively put my earnings on the flips you and Carol helped me with into some strongly cash flowing rental properties which have appreciated nicely.  I tried to talk you into doing the same at the time... Sorry the last line somehow got deleted.  Here is what I wrote" But I know you had (have?) reservations about buy and hold.  That is why I didn't get as pushy as I felt I should have about it.  

Originally posted by @Cal C. :
Originally posted by @J Scott:

Cal - You should have kept all those houses we were buying in 2010-2012! 

Me too...  :-(

 Umm, I effectively put my earnings on the flips you and Carol helped me with into some strongly cash flowing rental properties which have appreciated nicely.  I tried to talk you into doing the same at the time... 

 Yeah, but you didn't tell me you were going to be right!  ;-)

Originally posted by @J Scott:
Originally posted by @Cal C.:
Originally posted by @J Scott:

Cal - You should have kept all those houses we were buying in 2010-2012! 

Me too...  :-(

 Umm, I effectively put my earnings on the flips you and Carol helped me with into some strongly cash flowing rental properties which have appreciated nicely.  I tried to talk you into doing the same at the time... 

 Yeah, but you didn't tell me you were going to be right!  ;-)

 LOL! It probably didn't help that you knew my dismal track record at the time and BOA...

Sorry to being so late to my own party! I was working to fund those purchases ;)

Honestly I don't "bet" on appreciation but buy in areas where I and other anticipate appreciation to be above inflation, this preserving my cash flow.

@Cal C.  I would love to live in a brand new home but those don't work toward my numbers! Every house we buy we base it on the fact that we can rent it out when we are transferred! I actually did a rental analysis based on bah rates (the assumption that they reflect rent rates since that's their design) . In the 10 years that I studied my current area rates only went down once and the next year they were up! So if you bought your house based on if you could rent your house out you would have been fine! No one who bought out here bought with an exit plan! 

So question one what's your exit plan? Mines rental ;) 

Next my jump ship date was 7 years. In many areas that was this year based on 2007-2014. How many of you are right side up again? 

I know a lot of investors on this site talk about 70% and less than market! We have done very well buying short sales 5-25% undervalue so while we don't put money in them. They come with the equity! 

How many of you do refinanced? We don't! We just "unfinance" them to begin with! No extra paperwork same result!

@Alvin Taylor  

Personally that comes to knowing the area. In the areas we buy, they are not sexy people don't want it live here. The one incalifornia is the only navy fighter base on the west coast. More people rent than buy as they have no desire to come back. You also have the federal prisons and other transient professionals. So rents are higher. Based on understanding the market, the navy isn't going anywhere. This base is actually being set up as the newest f-35 squadron. Personally I would be more worried about hampton roads than out here!

Everyone has their own speciality! I give @J Scott a lot of kutos because dealing with contractors stress me out! On the other hand I love dealing with tenants!

Honestly I feel that the point everyone is missing isn't my "tools" or "margins". It's the fact that we have created an amazing investment strategy that works even in the face of a lot adversity and situations that most people would never have invested under!

What I hope people learn from this isn't what we do but the message that if there is a "will there is a way".

@Cal C.  It's all about the cash flow anything else is crazy in my mind. I want my cash back as fast as possible on every deal. I would rather buy a 10k ghetto house and get 375-400 a month then buy 250k property with a negative cash flow and HOPE it is worth more in the next five years.  Seems like a bad idea to me.  I sometimes wonder if anyone learned anything from 2000-2008?  

Best of luck to you

Originally posted by @Cal C.:

Unlike Elizabeth I didn't get it below market. There wasn't much you could buy below market back then when buying off of the MLS like I was. I did buy a brand new home.

But lets suppose for a second that I bought if 15% under market I'd still be losing on it or nearly so.  But that is only because Atlanta has come back considerably the last two years.  In 2011 and 2012, I would have been significantly underwater even if I would have bought it 15% under market.  

I'd have been a heck of a lot better off simply putting my money in the bank.  

Thanks for responding. I really appreciate it. This helps me. I'm trying to figure out what buying/analysis pareters make sense to me. I would like to avoid what was experienced in the late 2000's if possible. 

From your commemts back to @JScott it appears you are doing things different than in 2004. What did you learn from what you went through and how has that changed your REI decisions?

I concentrated much more on cash flow.  Also, I took advantage of the ebb and flow cycle of rents compared to house prices and was able to pick up houses at a much better rent/house price ratio.  To put it more simply, I was buying when house prices were low compared to rent.  Unlike the first time when I was buying just to be buying.  

Thanks for sharing so candidly @Cal C. .  I lucked out by getting into real estate investing after the crash when things were priced low. I'm even more lucky/blessed to be here on BP and learning from people's misfortunes, experience, and wisdom to guide my investing strategy :)

I don't bet on appreciation and do most of my pre-purchase analysis for potential deals based on cash flow. One thing I have NOT (and should) been considering is how things will play out if market rents drop. What are some factors that you believe cause market rents to drop? How do you go about considering this when evaluating deals you're looking at for buy & hold?

I don't really have data on how much they've fluctuated and why in certain areas. Just curious how you operate after what you've experienced. Thanks!

Great thread @Cal C.  

My observation and research as a non American investing in America is thet your appreciation is the least predictable of any western nation. I understand why too, it is because you have financial irresponsibility built in to your economy. By that I mean the whole government backed mortgages and REO system etc. So "banking" on growth is at best as reliable as heads we win tails we lose. I am buying houses today in Memphis for 40K that have sold for as much as 170K.

Where I do think you have an advantage over many countries is your ease of cheap credit and private lending wild west. This is also quite unique but means you can pay homes down fast and create equity with no growth.  But at the end of the day if you want bullet proof capital growth then places like New Zealand or Australia are the nations to buy in.

(Notwithstanding there are cities I am sure that have predictable growth in the USA. I am being more general, before y'all shoot me)

Dean Letfus, Memphisinvestment.com | 901 264 8674 | http://memphisinvestment.com/

Originally posted by @Cal C. :
Originally posted by @Jeffery Griggs:

@Cal C. thank you for sharing. I am just getting started in REI it is good to here things to be cautious about.

I listened to the @Elizabeth Colegrove podcast as well. My take away was that she is using high leverage to buy units significantly below market value (i.e. the short sells she talked about). That would appear to give her a buffer in the event of another downturn.

Out of curiosity was the house purchased in 2004 for 160K at or below the 2004 market level when purchased?

Again I am just starting out in this and trying to learn as much as I can. My take on the whole thing could be way off base.

Unlike Elizabeth I didn't get it below market. There wasn't much you could buy below market back then when buying off of the MLS like I was. I did buy a brand new home.

But lets suppose for a second that I bought if 15% under market I'd still be losing on it or nearly so.  But that is only because Atlanta has come back considerably the last two years.  In 2011 and 2012, I would have been significantly underwater even if I would have bought it 15% under market.  

I'd have been a heck of a lot better off simply putting my money in the bank.  

Not sure about how much Elizabeth has bought truly under market recently. I still consider the top 10-15% appreciation to be all air on a $175K house. If you can't re-sell or refi out to access the equity, what's it worth? Selling costs would kill a re-sale in the $200K range. LTV ratios will make a refi mostly not worthwhile.

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