Who Cares about Appreciation and Equity in a Depressed Market?
Niles, MI · Member since 2016 · 41 posts · 11 votes
Who Cares about Appreciation and Equity in a Depressed Market?
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Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes
9yI'm sorry @Hilary Hageman, but you have simply not been doing this long enough to experience the true joy of significant cap ex (which is unavoidable for any property), stagnant rent growth, increasing expenses, and the general illiquidity that comes from owning the type of property you are describing. Moreover, you have not honestly looked at what your numbers could be if you were investing in a healthy market. (Looking only at cash flow is not a good method for investing.) Not saying you cannot make money doing what you're doing (though I've run the numbers many times and struggle to understand how people make any money on SFRs in a flat or declining market over the long term), but I would be hesitant to conclude. given your newness,that you have come across the best strategy for wealth building.
22 Replies
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9yI love cash-flow but playing devils advocate having appreciation and equity build up is great if at some point you want less hassle (properties) in your life. And if you're on something other than a fixed-rate mortgage and rates increased you could find your great situation isn't so great and if property depreciates it could cost you money to get out of it. So you can definitely run scenarios where a lack of equity reduces options and increases risk.
- Niles, MI · Member since 2016 · 41 posts · 11 votes9y
Thanks, @Andrew Johnson. We actually bought our first rental for cash ($46K from a HELOC on our primary residence,) but we're in the process of pulling as much of that money out of the rental as possible through a 30-yr fixed-rate mortgage in order to allow us to make a down-payment on a second property. Our cash flow will drop by about $100/mo when we do this.
When thinking about a hedge against "un-sellability" in the future we have decided to only purchase 3+ BR homes. Although they don't appreciate much in this area, they do sell quickly, whereas 2BR sit and SIT.
Rumor has it that a lot of manufacturing jobs are coming to Indiana and Michigan areas over the next couple years which will hopefully help your properties appreciate. They will appreciate over time anyway or it certainly has in OKC. I don't particularly like rural areas as I had 3 just sold 2 and trying to get rid of the last. Does not fit my business model of driving an hour round trip to fix something. The 2 houses I sold went for a lot more than I anticipated however does not come close to the appreciation that my OKC homes have gained.
If you are cash flowing that much off 1 property in your area why not buy more?
I live in NW Indiana which is home to Gary and East Chicago. These areas are high cash flow with 0 to minimal appreciation. I know plenty of investors who love these properties because they can buy something for $25K and cashflow $500 a month. I personally stay away because my investments need an exit strategy. I want the option of selling to pull the money out if needed. In a no appreciation area, days on market are insanely long and you'll likely take a lose to dump it fast. Also keep in mind quality of tenants and cost to repair. Honestly in these areas, you're breaking even pretty quick (4yrs for you) and anything over that is profit. So if after 8 years, the tenants trash the place, it might make more sense to let the property go for back taxes and dump it cheap to another investor vs fixing it up again. That's a strategy several Gary investors employ. Good luck doing a cash out refi in an area with little appreciation too. The bank will want to protect the loan and appraisal will probably come back super low.
- Specialist · Ann Arbor, MI · Member since 2016 · 356 posts · 191 votes9y
Ben Leybovich wrote a blog post recently about the dangers of investing in very low priced properties for "great" cash flow. It's something to really think about, especially in terms of any long-term plans for wealth-building--something I knew nothing and cared nothing about in my 20s! We saw this first hand--sold our first home in 2002 in a working class neighborhood that was later hit very hard by the recession. I just checked the value a few days ago--even after rebounding, it is still worth less now than it was in 2002. By contrast, the home we bought in 2002 is worth more than double now, because it is in an appreciating market. Think long-term, maybe try to diversify if you can, some for cash flow, some for appreciation. Think also about the % increase of the original amount--would you rather have a 20% increase on 50K or on 500K? Also check out the article link about how appreciation gaps are widening significantly. There are almost always ways to invest in appreciating markets if you are clever about it, even getting both appreciation and cash flow.
- Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes9y
I'm sorry @Hilary Hageman, but you have simply not been doing this long enough to experience the true joy of significant cap ex (which is unavoidable for any property), stagnant rent growth, increasing expenses, and the general illiquidity that comes from owning the type of property you are describing. Moreover, you have not honestly looked at what your numbers could be if you were investing in a healthy market. (Looking only at cash flow is not a good method for investing.) Not saying you cannot make money doing what you're doing (though I've run the numbers many times and struggle to understand how people make any money on SFRs in a flat or declining market over the long term), but I would be hesitant to conclude. given your newness,that you have come across the best strategy for wealth building.
- Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes9y
I think both are important, but not every market offers the ability to have both types of property. Your appreciation markets are typically going to be your blue state coastal cities...but there are obvious exceptions to that generalization such as Dallas and Denver.
You need to bend to what your market offers you. If prices never go up in your market, focusing on trying to find an appreciating asset could be like trying to find a unicorn.
District Invest Group545 Reviews - Flipper/Rehabber · Crown Point, IN · Member since 2009 · 482 posts · 216 votes9y
Hilary,
Do you know the cash on cash return is, on your house? I live near Gary, Indiana and Gary itself, is a very depressed market. I can buy homes there for less than $20k, all fixed up and ready to go. I don't do much business there, because it's for a "special" type of investor. What I mean by that, is you have to be willing to take risks to B&H there. The tenant pool is not the best and it's difficult to find quality people that will pay on time and take care of your property. However, I have a couple of buyers who focus on Gary. They have a great property manager, who takes their time finding tenants and it's been working out very well for them. Buying a home for $20k and getting $600-$700 a month rent, equates into a great return! In my opinion, it just depends on your strategy and your goals. I'm sure a lot of people will tell you not to do it, but it's your call. If you have the "team" to pull it off, it can be very lucrative. The down side is, there isn't much equity when you go to sell. But if your buying at $20k, it doesn't take very long before your house is paid off and the everything after that is gravy. Here's what one investor told me about Gary and why he buys there. Show me another area that will bring in anywhere from $1800-$2100 a month, for an investment of no more than $60k and I'll buy there. He's referring to buying 3 Gary properties for $20k each or less and adding the 3 rental amounts together. He's right too. Where can you find that kind of deal? Good luck with your business.
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes9y
@Hilary Hageman Also keep in mind that my "un-sellability" perspective with SFRs is more rooted in my California experience. Seeing friends buy a house for $800K (granted not for cash-flow), see the value drop to $500K, their "teaser" interest rate expire, and all of a sudden their choices are:
1.) Have the property foreclosed on and destroy their credit for 7 years.
2.) Be in a cash-flow negative situation on a monthly basis after the interest rate is raised.
3.) Come out of pocket because they're both upside down in the property and they now have to incur selling costs, realtor fees, etc.
Most people I know went cash-flow negative until the market came back. Even when they sold at what was a profit on paper, that didn't take into account the cash-flow negative situation they were in for years. Here's to hoping it was a once in a lifetime challenge for many ;-)
Originally posted by @Hilary Hageman:
When thinking about a hedge against "un-sellability" in the future we have decided to only purchase 3+ BR homes. Although they don't appreciate much in this area, they do sell quickly, whereas 2BR sit and SIT.
Both ideas are well founded. Do whatever to avoid known issues.
- Investor · Coplay, PA · Member since 2015 · 404 posts · 315 votes9y
Originally posted by @Hilary Hageman:
Thanks, @Andrew Johnson. We actually bought our first rental for cash ($46K from a HELOC on our primary residence,) but we're in the process of pulling as much of that money out of the rental as possible through a 30-yr fixed-rate mortgage in order to allow us to make a down-payment on a second property. Our cash flow will drop by about $100/mo when we do this.
When thinking about a hedge against "un-sellability" in the future we have decidded to only purchase 3+ BR homes. Although they don't appreciate much in this area, they do sell quickly, whereas 2BR sit and SIT.
I buy in a depressed area. I buy so that if they never appreciate or sell I am okay. I do not like to buy above 3 bedroom, to many people in the house. LOL I just bought 2-5 bedroom homes. Just could not pass up the deals. Paid the same price I would for a 3 bedroom and needing less work. Will get an extra $200 a month.
Learn more about the market buy driving the neighborhoods and studying Zillow and Craigslist and For Sale By Owner signs. As you learn your market you will find that what you are paying now is probably a high price. Since I did this I have found a lot of homes for 1/3 the price.
If the 2 bedrooms are hard to sell I would research that market for rents and
tenants. Your biggest profit will be here.
- Niles, MI · Member since 2016 · 41 posts · 11 votes9y
Thanks so much for all of the advice. So good to hear from people from different areas, markets, and strategies, all of whom have more experience than I do!
@Rob Lane: Thanks so much for the hopeful news. We're going to try to dip into the IN market (South Bend) a bit more, as it is just larger and shows more economic stability. Same types of homes, though. No appreciation but steady rents.
@Adrien C.: Good to hear from someone in a similar post-industrial fall-out Midwest market. Thankfully, our appraisal actually came in at $6000 (8%) better than what we paid for it.
@Sarah Lorenz: Really good advice. I will read those articles today. I think you are right when it comes to long-term wealth building - that appreciation needs to be a part of the strategy. It will definitely be a challenge to find those properties in our market, but I think I need to do some more digging before I totally right off that possibility. In your opinion, how to multi-families compare in terms of appreciation to SFHs in a depressed market like mine?
@John Chapman: Absolutely I am a newbie of newbies. Hence the question mark at the end of my post title. Hoping to learn from wiser ones here. :)
@Russell Brazil: So true about the different markets found in this huge country! I have a difficult time imagining life in a rapidly appreciating area with large population growth. Our area has been steadily declining for decades along with the rest of the Midwest. But I just keep reminding myself that every market has opportunity somewhere. I just have to find it.
- Niles, MI · Member since 2016 · 41 posts · 11 votes9y
@Scott Steffek: I don't want to dip into Class D properties (although there are LOTS in my area!) Mostly because I don't think we have the team or the experience to handle that type of tenant. Our C/CR on the property is 73.4%. We invested $6K and are getting $370/mo in cash flow. Our property is a solid class C with grad students at Notre Dame for tenants. Kind of a dream situation, so we know we haven't really been prepared for handling difficult tenant situations. We'd like to look into multi-families but are nervous to do so given our lack of experience dealing with tough tenants.
- Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes9y
@Hilary Hageman don't get caught up in the cash flow vs appreciation debate. You should always be looking for BOTH. Settling for only one or the other is like settling for just half a pay check... As a real estate investor you have the opportunity to get both, so why not go after both? Granted each market will have different weighting to both cash flow and appreciation, but the deals you should be looking for should give you both. If it does not, you are settling... and you are not being efficient with your funds or time.
- Flipper/Rehabber · Crown Point, IN · Member since 2009 · 482 posts · 216 votes9y
Hilary,
i wouldn't go into the "D" areas either, unless you have a great deal of experience. It all depends on your "cup of tea." I think Arjen made an excellent point when he said look for appreciation and cash flow. That is most definitely the best way to go. That type of strategy will cost you more money in acquisition costs but in the long run, you'll be much better off financially. Good luck and let me know if there's anything I can help you with.
There are many ways to think about this topic. I would recommend reading articles by Ben Leybovich who wrote a lot about this topic.
From what I've seen, I think the most common mistake that people make is underestimating the Cap-Ex costs. Note that when people say cash flow, they mean NOI minus Debt Service minus Cap-Ex Reserves. It easy to figure out what your Debt Service is; it's not as easy to figure out what your Cap-Ex Reserves should be. I've seen people blindly set aside a certain percentage of the rental income (say 10%) without really trying to calculate what the true Cap-Ex costs are. While same could be said about how people calculate Vacancy Factor and Maintenance Reserves, I notice that people struggle the most with Cap-Ex Reserves.
This especially becomes a problem when folks rely primarily on their rental income to eat and live. Because Cap-Ex costs can suddenly pile up without warning, not setting aside enough reserves could spell trouble.
That said, I do agree with others that the cash-flow-versus-appreciation debate is somewhat a red herring. It’s very important to ask and understand why you are getting a high versus low cash flow. It’s also important to consider why you think the property prices will or won’t appreciate. But ultimately the question is whether the property you buy will get you the returns you need when you exit.
Have you consider using the IRR, MIRR, or FMRR to underwrite your properties? It's a bit tricky to use at first, but I've found it far superior to other methods of tracking your investments. And I personally think it's a useful tool regardless of whether you are focusing on cash flow or appreciation.
Chris
- Niles, MI · Member since 2016 · 41 posts · 11 votes9y
@Chris K., thanks so much for the input. I tried to follow Brandon Turner's advice in his Book on Rental Property Investing regarding how much to set aside for CapEx. The house is small (800sq ft) and everything including roof, furnace, flooring, and kitchen newly updated so I'm putting aside $120/mo for CapEx.
I'll have to do more research about those other methods of property analysis. Thanks!
- 9yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
your markets is great as long as you keep buying .. you will want at least 20 to 30 of these to create any kind of wealth over time. owning a few is just not going to do it for most folks
but you live there so you have to play the hand your dealt
- 9yMax BrunkePro MemberDeveloper · Portland, OR · Member since 2015 · 21 posts · 5 votes
One is not better than the the other. It is important to consider where you at in your investing life span when optimizing for cash flow or appreciation. In the beginning, you may need the cash flow. As you build your income and portfolio you may want to transition to deals with more appreciation or stick with higher cash flow.
I am just beginning my investing career and will need the cash flow.
Just run the numbers and optimize your investments for what you need most! - 9yPeter TverdovBusiness MemberDeveloper · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes
Appreciation and equity are what make people extremely wealthy. Not cash flow (which is great BTW).
- Niles, MI · Member since 2016 · 41 posts · 11 votes9y
My question is how to achieve appreciation in my market. I'm not willing to invest in a market I don't know (a blue state with appreciation) and which is hundreds of miles away. I'm just not sure I can get reliable appreciation in an area with at best stagnant at worst steadily decreasing population and employment numbers.
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