Proponents for appreciation strategy?

39 Replies

I don't think it necessarily looked down upon, but while you can calculate cash flow pretty accurately, it's hard to calculate appreciation. Appreciation should be looked at more like a bonus.

@Rob Beardsley   look no further than were you live.

my first house was in Milpitas Ca I paid 79k for  second was in Palo Alto I paid 183k. for third house was in Silverado up at Napa ( recent bad fire just missed it) paid 420k for it.. and 2 homes in Portland Oregon one went up 400k in 5 years current house went up 600k in last 4 years ( although I built this one from scratch so 150 to 200k is forced appreciation.

Land I own in Rohnert park CA 4 acres I paid 27k for in 1993 ish on market for 3 million.. Tree farm in Oregon I paid 1.8 million for took 2 million in timber off of and sold for 2.7 million allin 10 years time..  so on and so forth. 

there are simply many ways to make money in real estate appreciation being one of the major drivers for wealth if you can't scale sufficiently with cash flow.  Or don't care to be a landlord.. but I know many in the landlording business that have gotten both.. most anyone who bought apartments 10 years ago have cash flow and appreciation.. 

Why is it no one doubts that inflation happens yet so many are skeptical when we call the same economic force appreciation?

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Here in California you can have both for sure. ITS ALL ABOUT YOUR PURCHASE PRICE! Get that discount from the start when you purchase and you will have instant cash flow. Market and put in the work to find the good deals and you will have cash flow always and appreciation for the tax free refinance again and again over time.

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@Account Closed It's not totally apples to apples in your example, to buy the preferred stock you need the $150k in cash, the same property in Memphis can be bought for $30k or less. Your gain may still be minimal from an appreciation perspective, but any returns you do realize are much larger (percentage wise) than that same or greater growth in the stock. Your greater point is still valid, but an argument can definitely be made for both sides.

@Rob Beardsley

Here is a real life example.

Around 2004, I bought a property for approximately $890k in Brooklyn, NY and had very little monthly cash flow.

TODAY, That property is now worth close to $3 Million and Cash Flows around $5k per month.

I'd like to Contrast that with a friend of mine, Steve.

Steve bought approximately the same Value of properties, but for Cash Flow in Bristol, CT.

He has been making $1k Cash Flow for the past 13 years.

The Value of his properties, which was similar to mine when I first bought, bearly move up, probably around $100k more.

His Cash Flow never really grew, mostly because the Property Taxes kept climbing with any increase in rent in his area in Bristol.

The Biggest problem that Steve had was that he lived in NYC.

In 2004, his apt that he rented was renting for $2,000 per month. TODAY, Steve's rent is over $4,600 per month.

If you think about it, Steve's rent moved up by $2,600, which is $1,600 MORE than the $1,000 he was making in Cash Flow from his Bristol, CT properties.

IN OTHER WORDS.... STEVE is actually LOSING cash flow by NOT buying his NYC Apt and instead invested in a Cash Flowing area where there was NO Apprecation.

So what's the lesson here? If you are RENTING in a high appreciating area, that mean your Rent will be moving UP over the years. If you buy in a stable Cash Flow area where the Cash Flow does not meet your rent increase.... YOU ARE LOSING.

I hope the readers of this post understand the risks that are involved by this scenario, which actually happened. To mitigate the risk, if you intend on living in a high appreciating area, you should first consider owning with a 30 year fixed rate Mortgage to lock in your "EQUIVALENT RENT" and prevent yourself from being Priced out of the Market.

Had Steve actually bought his Apt here in NYC in 2004, he would have locked in his monthly payment AND also made about $1 Million or so in Appreciation. BUT it's not all that bad....... at least he made $1k per month for 13 years..... so that's $1k x 12 months x 13 years = $156k in cash flow.... or is that bad in considering he could have saved $1,600 x 12 month x 12 years of rent payments and $1 Million in Appreciation? You decide.

Steve had to eventually leave NYC and rent in another cheaper area.

Investors might consider that market appreciation is 100% passive and cash flow is 100% work. Someone spends energy for the cash flow part to happen. One can watch the grass grow and still get appreciation. 

My personal take is normal rei landlording is a big hassle/liability. If you are unable to experience appreciation you might miss out on best part of REI, passive wealth creation.

Good luck!

Originally posted by @Rob Beardsley :

A major takeaway for me here is that completely ignoring appreciation may not kill you but certainly hinder overall returns. On the other hand, buying on the premise of appreciation is speculative and dangerous. How do you all incorporate appreciation in your investment philosophy/thesis and underwriting?

 It all is considered high risk. Speculating on cash flow can be very dangerous too. Employer leaves town ( see  the abandon properties across the nation) and your cash flow vanishes.  Now you are really stuck. 

As far as overall speculation, the locations that historically appreciate are already known as are the ones that don't. Really should not require very much speculation on what the future holds longer run. The rates of appreciation or lack of are published to account for any thesis. 

I had a conversation awhile back about this subject. It was comparing two cities. One city was loaded with properties priced the same as 20 years ago and the other city did not have one property priced the same...not a single one (all the dirt had appreciated). Which leads into possible redevelopment. 

When the actual differences are measured on those redevelopment stages, these can be 8 figure concerns on the same original investment prices of 20 years ago (400k). This actually happens. Now ask yourself again if you think appreciation matters?

Good luck!

Why not incorporate both strategies? Buy properties that cash flow in appreciating markets? 

I know it's easier said than done, but it can be done. 

"TODAY, That property is now worth close to $3 Million and Cash Flows around $5k per month."

Tell us more....I find these numbers almost impossible to believe. Your rent has increased by over 300% in 13 years.

@Thomas S.
$890k to $3 million from 2004 to present in Brooklyn doesn't sound too crazy .

Prices have gone up like that in parts of CA too.

Rents have also gone way up as well .

@Matt R. We will see this more and more in L.A as there is a push for more density. Someone bought a small building decades ago and it just brought the in some side income and then they start building new luxury condos or townhomes on the same block your land value goes way up.

I used to live in Hollywood and my block was all older 50s or 60s apartment buildings but now there are several brand new buildings where those old buildings used to be .

Best and highest use .

Only really happens where land is scarce.

I just saw one company is building 3 large buildings ( on different sites ) in the Warner center area . The valley is going to become higher density for sure.
Prices have gotten super crazy on the Westside so many are priced out even if they have good paying jobs .

@Joseph M.

"Rents have also gone way up as well"

I understand the high level of appreciation however it is extremely rare (practically unheard of) that rents keep pace in those markets and as such cash flow decreases it does not increase as a result of appreciation.

In the example value at $890K rent to break even would be about 8K per month. With appreciation making the value 3M rent would need to be 27K per month. Pretty sure we all know that is not the case.  

The opportunity value alone on a property with high appreciation is costing most investors far more than any property could produce in rent. When a property has high appreciation and you do not pull out the cash you are losing not making money from your investment.

Truth be told speculative investors do not understand the value of money. All they ever see is the dollar signs created by appreciation they seldom ever actually see any money.

Appreciation is only a word until the money is accessed which most will never do.

Yes I know what you mean. I know some with equity are refinancing to get cash out to put towards properties with a higher cap but I know a bunch of landlords aren't .

In L.A at least there are a bunch of mom and pop landlords many of whom inherited a small building or two and they are paid off and they are just comfortable living off the rents that come in . Rents are high enough to support their lifestyle and turnover is very low for most of them if they keep rents a bit undermarket.

I don't think many of them even do the calculation of what their return might be if they had to buy the property at today's market value.

Originally posted by @Joseph M. :

Matt R. We will see this more and more in L.A as there is a push for more density. Someone bought a small building decades ago and it just brought the in some side income and then they start building new luxury condos or townhomes on the same block your land value goes way up.

I used to live in Hollywood and my block was all older 50s or 60s apartment buildings but now there are several brand new buildings where those old buildings used to be .

Best and highest use .

Only really happens where land is scarce.

I just saw one company is building 3 large buildings ( on different sites ) in the Warner center area . The valley is going to become higher density for sure.
Prices have gotten super crazy on the Westside so many are priced out even if they have good paying jobs .

Yeah, city of LA is favoring this now. Some of 50s 60s stuff is prime. I know of a recent 10 unit 50s style that traded hands. Dude has over 1000 units and said he knows he over paid for current as is cash flow value, not sure of sale price around 4 million is likely, although it grosses 20k mo. The thing is, at a redevelopment stage (condos) it is worth north of 20 mil? and that is just at today's across the street values. 

I went to open house yesterday, condo across from Wholefoods. Forget about it, in the 5 mins I was there, I could tell there were 3 buyers going offer on it. 

I read a few days back, LA Times I think. LA was 350,000 units short of what would be considered normal inventory. That is an upside down inventory scenario today that is virtually politically impossible to resolve in our lifetimes. So these revelopment future options are very real in LA. 

"they are just comfortable living off the rents"

Makes no scenes at all. They have no concept of the value of money and would make greater returns with no hassle if they sold the properties and put all the cash in a investment fund.

With all that equity they are losing more potential income every year than they could ever come close to making from rent. Weird.

Originally posted by @Thomas S. :

"they are just comfortable living off the rents"

Makes no scenes at all. They have no concept of the value of money and would make greater returns with no hassle if they sold the properties and put all the cash in a investment fund.

With all that equity they are losing more potential income every year than they could ever come close to making from rent. Weird.

 Perhaps and some of the mom pop smaller LL types are not super sophisticated sure. In the example of the 10 unit above, she paid 900k in 2000 and sold for my guess is 4 mil ish in 2017. She was making over 2% in LA yesterday and in a location that was always in high demand, easy to rent and easy to raise rents. She never updated, original 50s kitchens, bathrooms and even floors ( hardwoods) seriously not one red cent to update in 17 years, even with all that she did just fine. This is not all that uncommon in LALA land. Now others might say she was a brilliant RE investor still. The next guy we shall see and I am sure he knows exactly what he is doing when compared. 

@Rob Beardsley For what it's worth, I think you can make the argument that appreciation could be a useful tool if you don't need cash this moment.  If I buy a property in some horrid Cleveland suburb for $50K and I make a great cash-on-cash return then I get taxed on that.  If I'm 45 years old and in the prime of my earning power I might not need that extra income today nor do I want to pay a high marginal tax rate on it.  If I were to use that same money as leverage in a "break-even" deal given rents today then I get to have someone else paydown the mortgage and hopefully have appreciation work magic over the next 20 years.  If it really is an appreciating market then rents will rise along with value.  When I hit 65 and want to retire I have something that has a.) cash-flow, b.) the opportunity to refinance and pull cash out, and/or c.) something that I can 1031 into something more "cash-flow friendly" for my retirement years when my marginal tax burden won't be as high.

That said, I think of the real challenges for a lot of investors is that they would have to be able to make it through a "bad time" if they bought a property with no, zero, or negative cash-flow.  Both fiscally and emotionally that can be tough to stomach.  One of the benefits to (at least) moderate cash-flow is that even if rents drop 20% you can still break-even.  Those zero-cash-flow properties that are/were purchased for appreciation will start to slowly (or quickly) bleed cash. 

Originally posted by @Thomas S. :

@Joseph M.

"Rents have also gone way up as well"

I understand the high level of appreciation however it is extremely rare (practically unheard of) that rents keep pace in those markets and as such cash flow decreases it does not increase as a result of appreciation.

In the example value at $890K rent to break even would be about 8K per month. With appreciation making the value 3M rent would need to be 27K per month. Pretty sure we all know that is not the case.  

The opportunity value alone on a property with high appreciation is costing most investors far more than any property could produce in rent. When a property has high appreciation and you do not pull out the cash you are losing not making money from your investment.

Truth be told speculative investors do not understand the value of money. All they ever see is the dollar signs created by appreciation they seldom ever actually see any money.

Appreciation is only a word until the money is accessed which most will never do.

 You really think most people in appreciating markets never sell or refinance their properties and just die with them?   

You also make the mistake that others do in low value markets and assume expenses inflate at the same rate as rents.  A refrigerator costs the same for an apartment in a low rent city as it does in a high rent city.  You can't generalize using simple formulas.  

You have to be able to reasonably underwrite for commercial real estate even small multifamily.  There is a lot more to consider for an investment than the expected initial cash flow and it does a disservice to potential investors to blindly push them into the perceived highest initial cash flow investment as the sole factor to consider.

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