Proponents for appreciation strategy?
Rental Property Investor · New York, NY · Member since 2017 · 300 posts · 168 votes
Proponents for appreciation strategy?
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes@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..
39 Replies
- Investor/Real Estate Agent · Portland, OR · Member since 2014 · 198 posts · 119 votes8y
Hello @Rob Beardsley! Although I do completely agree with you that cash flow is king I can understand a couple points from the other side. Some investors are willing to purchase in an "up and coming" area and lose maybe 100-200 bucks a month in cash flow and hold the property for a couple of years banking on the area being revitalized and for them to double if not triple their initial investment. I have seen that time and time again in the Portland market and areas with low cashflow. For instance if someone knows that there is a development planned for a couple years out that will severely increase the value of their property they are willing to take an educated gamble.
If you catch wind that a fancy grocery store is popping up a block away from a 4-plex for sale you can make a pretty well-informed decision that there will be appreciation in the properties future. I also think that people can predict the direction are certain city is growing. If you notice that home values are consistently increasing throughout the city but hasn't quite hit one specific area yet then it might be worth buying property there and playing the waiting game. I hear stories like @Jay Hinrichs' all the time and it just makes me kick myself for not playing the appreciation game.
For my personal investments I do not break my cashflow rules but I also do not have a lot of capital to gamble with.
- Rental Property Investor · Los Angeles · Member since 2015 · 32 posts · 8 votes8y
@Llewelyn A. thank you for the detailed posts and s/s numbers, they are very helpful as I weigh up what strategy I should pursue. It's clear one can't rely on initial cash flow alone and must project future cash flows; as others point out costs could grow faster than rents (e.g. rust belt towns with declining population).
Where I'd be interested to hear your thinking is on reserves and the liquidity of the properties you buy.
e.g. with hindsight you can always point to which of these two properties provided a greater total return over ownership:
a) zero/low cash flow property (on day one) that pays down mortgage, but appreciates and cash flow builds as rents outpace costs (i.e. your Brooklyn example)
b) higher cash flow property (from day one), but lower appreciation and lower growth of cash flow as rents and costs grow with inflation only (e.g. a stable Midwest city perhaps)
I would tend to agree that if you can get it "right" and can predict rent growth etc then property a) likely offers potentially higher returns.
The difficulty I have is thinking about the risk embedded in making these predictions upfront coupled with the inherent illiquidity of property. When you have a low/zero cash flow property your margin for error is lower, e.g. when things go wrong (unexpected void periods, needing to await insurance claim etc) you may quickly bleed cash and reach a crunch point.
I'd be interested to hear, perhaps in the context of your total portfolio, how you build in contingencies to protect against this? Reserves would certainly be one aspect of this, or lines of credit against equity in other properties, or perhaps certain properties in your portfolio that are more liquid and/or earmarked to be the first to unwind (sell) to free up capital if unexpected events lead the total portfolio towards a possible crunch point.
Overall it appears to me that zero/low cash flow properties may only offer better risk/reward in a larger portfolio or where cash can be found from elsewhere (salary etc) to guard against negative events.
Thanks!
- Investor · Joplin, MO · Member since 2015 · 76 posts · 78 votes8y
The area of the Midwest I am in is a slow appreciation area, so cash flow is the primary concern. Most of the appreciation in my area is going to be forced appreciation. For example I have a rental that i purchased for $15k, rehab was $12k and the property appraises for $50k.
- Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes8y
There are different strategies for different cycles. Anyone that bought in 2008-2013 has been able to realize major appreciation in most markets, so any poor cash flow didn't matter. Ask anyone that bought in 2004, 2005 and 2006 for appreciation and they will tell you what happened wasn't good. Right now, I think we are closer to the top than the bottom, so buying for cash flow in my mind is the only way to look at it. Once the market crashes again, then buying for appreciation is a good strategy.
- Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes8y
Hi Richard.
As far as reserves and liquidity is concerned, that is a subjective matter.
There are a lot of Investors, especially in the beginning of their involvement of Real Estate, that absolutely need the Liquidity from their Investments. That's why the initial Cash Flow calculations is the one that these Investors concentrate on to the exclusion of future cash flows as well as they don't know or understand the calculations.
In Reality, if we equate Cash Flow with Liquidity, in other words, the higher the Cash Flow the more you consider the Investment to be Liquid, then it's a fair argument.
However, if your Risk Tolerance is set to a point where you cannot stomach a level of Cash Flow that is at break even, then this kind of Investing is not for that person.
In the case of my property portfolio, Appreciation is not about the Value of the Property as it increases ONLY. It's about Rent Appreciation above the Expenses, or Cash Flow Appreciation. Without the Cash Flow appreciation, it is unlikely to have at least some Value Appreciation, btw.
So far, all my properties over time became more liquid as the Cash Flows Increased. In fact, my older properties cash flowed tremendously at the time the Mortgage Interest Rates dropped and my Partners and I had refinanced to lower rates which implies lower Debt Service Payments and that implies higher Cash Flow, when then implies higher liquidity.
I'm used to it over the 2 decades of buying properties this way. We wait for Cash Flow (or liquidity if we used it interchangeably).
So there is a bit of a gap between break even cash flow years and the future years in which will support any needed capital expenditures.
Normally, by the 3rd year, the property can cash flow enough that my Partners and I can just stop taking our share of the cash flow and allow it to accumulate in the Property's Bank Account to pay for a capital expenditure.
One of us may need to lend money to the Investment, but that's very rare. If it happens, none of the Partners will take Cash Flow out until the Lending Partner is fully repaid.
As far as natural disasters which can put us in even worse of a situation, we will be dependent on our Insurance which also includes rental loss provisions as well as Damage and repairs. In 20 years, we never needed to call our insurance for that, however.
We attribute that to NYC being in a sort of area where Natural Disasters do occur on rare occassions, but not as frequently as say, Houston or New Orleans, the Carribean, etc. The properties we chose are also in locations that are on higher ground and never in a flood zone.
The Bottomline is that you cannot protect for every single situation as nothing is fully guaranteed. You cannot even guarantee the Sun to come out tomorrow.
This boils down to 2 things.... how conservative is your spreadsheets which will allow you to accumulate Cash Flow to increase liquidity and to what extent are your Investments are vulnerable to Natural Disasters.
There is one other disaster that should be protected, however. That's Economic Disaster. NYC is quite Shielded from Economic Disaster.
If you consider that in 2014, NYC has about 8.5 Million people. BUT, the amount of tourist that visit NYC was around 55 Million. Imagine that!
IN 2016, that increased to 61 Million Visitors! All these Visitors translate to continued economic stability.
There are so many different Industries that NYC has that each are a hedge as one may fall. We have Tourism, Finance, Insurance, IT, Fashion, Music, etc. You name it! The diversity wraps NYC like a shield against economic disasters.
HOWEVER, take a city like Detroit before it became bankrupt. Detroit was 90% dependent on Automotic. Obvously, if Domestic Automotive failed, so will Detroit, and it did.
Essentially, I balance the risk of some sort of decline in value, either economic or physical damage, during a small window where we are vulnerable until the rents move up to a point where we are no longer as vulnerable. That is about 3 years in our strategy.
The Partners all know this and have some reserves if we actually may need it. But in 20 years, we have never executed a contingency plan other than during a construction phase where we encountered unexpected work that was hidden.
Hopefully I have answered the question and not digressed too much!
- Real Estate Agent/Property Management · Houston, TX · Member since 2014 · 1k+ posts · 827 votes8y
The general rule of thumb is that buying for appreciation is speculation, not investing.
Having said that, I always look at how the property has been appreciating when I decide whether or not to recommend it to my investor clients. But I look at appreciation as an added bonus, not the main reason to purchase a property. - Rental Property Investor · Los Angeles · Member since 2015 · 32 posts · 8 votes8y
@Llewelyn A. understood thanks very much, that really helps me understand how you think about risk/return and have the contingency plans in place for those initial years where cash flow is tight.
In my view this argument on whether or not weighting towards higher appreciation/lower initial cash flow markets is sensible or not cannot be answered unless you have a specific time-frame in mind.
My feeling is that if you have a 20-30yr time-frame you are likely taking larger risks/speculating by betting on markets where initial cash flow is high but the market could see both property price depreciation (in real terms) going hand in hand with rents not keeping pace with cost inflation. @Fred Heller let me know if you disagree?
I've got a couple more follow on questions if people have the time!
1) In London where I've invested (or maybe speculated!) to date, I felt that one could identify the waves of gentrification that sweep through neighbourhoods (people renovating, new transport links, new cafes/bars/restaurants opening etc). Its a city without enough houses being built and no more space. I can see that you might be able to do similar in NYC and position for appreciation. However to be more analytical:
a) which are the top 3-5 stats you look at to try and pick neighbourhoods that will see price and rent appreciation over the next 3 years?
b) can I think about other growing MSAs in the US like DFW in the same way? i.e. these cities with way more space and with industry/employment more scattered and less concentrated in downtown. I worry that I may try and apply my experience in London to other US cities where it's completely inappropriate!
2) With multifamily one of my concerns is that cap rates across the board are repriced upwards as the US/world economy exits this period of exceptional monetary stimulus. As the Fed unwinds their balance sheet (i.e. sells all the bonds they purchased under QE) and possibly hikes rates more than expected, you could see all rates of return (e.g. 30yr treasury rates, corporate bond yields, high yield etc etc) widen. Surely cap rates get dragged upwards in this scenario too, with commercial/multifamily prices therefore dropping?
This is one reason I'm thinking to start with a small SFH portfolio where prices are more pure supply/demand for housing and not driven by the yields global investors demand over and above risk free rates.
Any thoughts much appreciated!
- 8yAnthony GaydenPro MemberRental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes
Here is a personal example of a property I own. I get both cash flow and appreciation off this property.
$179,000 Purchase Price
$44,500 Down Payment
$5000 closing costs
$29,280 Gross Income (Annual)
-$1229 Vacancy Loss
-$10,140 PITI (Annual)
-$2700 utilities
-$2500 property management
-$5000 maintenance and repairs (approximately)
$7711 cash flow after expenses
So based on my initial investment of $49,500 I got a return of around 15% based on cash flow. Not bad right?
I have owned the property for 3.5 years. It has gained approximately $100,000 in value since I purchased it.
100,000/3.5 = $28,571 per year
So based on my initial investment of $49,500 I got an annual return of 57% based on appreciation alone.
Appreciation came out the clear winner in my personal example. I will however state that I got very lucky there and never planned on making such good gains. Also there is no guarantee that appreciation will continue at the same rate or at all. The market where my property is located is not nearly as dense and restricted as California or NYC but I do expect there to be moderate appreciation in the future.
- Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes8y
Hi Richard.
"My feeling is that if you have a 20-30yr time-frame you are likely taking larger risks/speculating by betting on markets where initial cash flow is high but the market could see both property price depreciation (in real terms) going hand in hand with rents not keeping pace with cost inflation." <---- ABSOLUTELY TRUE!!
However, the concept of REAL versus NOMINAL Prices is difficult for most investors, especially new Investors to understand. People really need a general understanding of what Real Prices are versus Nominal or they don't understand the Risk they take by buying where Real Prices are actually falling despite Nominal prices staying exactly the same. I normally like to state this by a real life example involving one of my friends, Steve. Steve lived in NYC and rented but bought in Bristol, CT for a long term cash flowing rental at the same time I bought a 3 Unit Building in Brooklyn. While Steve's Cash Flow throughout 14 years from his CT investments remained the same, approximately $1k per month, the rental he was in moved up from $2,000 per month to $4,600 per month in those 14 years. If we looked at Value, the CT investments did not move up in Price. However, the apt Steve rented moved from $1 Million in 2004 to almost $2.5 Million today.
This is the story about Real Prices that depreciated in that CT Investment and at the same time, NYC prices, which appreciated, moved up in NOMINAL PRICE to keep pace with inflation. However, generally, because of higher demand, NYC Prices tend to rise above inflation.
What most readers of this post should try to connect is that Real Prices are Prices that adjust for inflation while nominal prices are just the price. Let's say Steve's CT Investments were $1 Million, the equivalent as the apt he rented in NYC. The NOMINAL PRICE is $1 Million. Over the 13 years, Steve's NYC Rental moved up in NOMINAL PRICE from $1 Million to $2.5 Million... but adjusting for inflation, it's more like $1.5 Million. Now, if we adjusted Steve's $1 Million Investments in CT, since the Nominal Price of that Investment did not move up significantly, the REAL PRICE, which is adjusted for Inflation, will probably be somewhere around $700k or lower.
The problem with these concepts is that it's very difficult for 90% of people to understand until they spend the time to study economics. It's much easier for these 90% of people to think that Major Metro Cities are spectulative appreciating markets rather than places which lowers the risk of suffering from real price deflation, which normally happens in non-Major Metro areas.
However, this is why I would ask the readers of these posts to add economics to your chest of investor tools. It's awesome and helps you to mitigate Real Price losses (versus nominal).
That being said, and to continue this discussion a bit further, if you bought an Investment with a 30 year fixed mortgage in an area where Real Prices are actually Stable or Rising, you benefit HUGELY. The Lender receives a fixed payment in Nominal Dollars. But, since the Dollar becomes weaker as prices rise, the borrower benefits by paying the Lender with weaker and weaker dollars.
For Londoners, however, I think there isn't a 30 year fixed rate option? This can impact your strategy but that would be specific to your ability to lock in long term rates at a reasonable cost.
These two concepts, Real Price Stability (or increase) in Large Metro Areas and being the Borrower, paying with weaker dollars, are the foundations on why I actually buy ONLY in Major Metro Areas (and specifically Brooklyn).
Now that I got that out of the way, I can give you my thoughts on your other questions.
1) Identifying the waves of Gentrification is a HUGE Bonus and one that I utilize in picking my locations. However, there must be a certain amount of Gentrification that MUST have taken root. I call this the Protection against Reverse Gentrification. In your question about top 3-5 stats, one happens to be that there must be some significant Gentrification so that in a downturn, it cannot be reversed.
I tend to look for at least 3 major Project Developments. In the areas that I invested, there were 3 Major Project during the last 15 years. 1) Brooklyn Barclay's Center, 2) The Rebuilding of the World Trade Centers and 3) the Redeveloopment of the Brooklyn Navy Yard. There were others, but these pumped in multi-Billion Dollars of development money. The Barclay's Arena had been completed and was a huge boom to the area. The World Trade Centers are partially done and will be completely done very soon. The Navy Yard development is ongoing but getting bigger and bigger.
Really, it's incredibly difficult to go wrong with any buy and hold in the area had you invested 15 years ago like I did.
There are other important issues to follow, however. Because NYC is similar to London in it's importance internationally, we need to follow the Global Economics. When our currency gets weaker, there is huge amount of inflows into our City's economy. Tourism rises as well. Basically, we are seen as a "Flight to Safety" City, stabilizing any weakness that we see in other Cities in our Country (UK and US, that is). It's very typical to see large amounts of Chinese, Italians, etc. buying entire floors in large buildings. We get crazy amount of Tourism and AirBnB Guests... 66 Million Visitors last year! It's really hard to lose in places like NYC if you bought right.
However, you still have to narrow down the economics to the neighborhood and look at the projects as I described above.
When it comes to the MSA numbers, I tend to dismiss them quite a lot. The NYC Metro MSA is as follows from Wiki: The New York metropolitan area, also referred to as the Tri-State Area, includes New York City as the most populous city in the United States, Long Island, and the Mid- and Lower Hudson Valley in the state of New York; moreover the five largest cities in New Jersey: Newark, Jersey City, Paterson, Elizabeth, and Edison, and their vicinities; six of the seven largest cities in Connecticut: Bridgeport, New Haven, Stamford, Waterbury, Norwalk, and Danbury, and their vicinities; and five counties in northeastern Pennsylvania.
That's crazy to include all those areas and say that NYC in itself is indicitive of what is happening there. So the numbers for the MSA is skewed. I would rather concentrate on the numbers of the area I am investing specifically.
In regards to 2) the unwinding of QE, I was hoping this was going to be done FASTER. It should raise Inflation and Interest Rates as we reverse those purchases.
You may look at the Cap Rates which may increase, but I look at it as all my fixed Rate borrowered money will be a huge benefit to me and a disadvantage to the Lenders. In reality Lenders protect themselves by buying counter inflationary insurance or even PUTs to protect themselves against rising inflation.
If you do your research, you will also find that during the 80s, while there were sky high inflation and interest rates, this did not cause the housing Market here in the US to implode. In fact, the Nominal Prices was just about stagnant versus the deflation of Real Prices. But that's fine since the trade off is that I pay the lenders with weaker dollars.
Also, since I have multi-family properties, general overall inflation may cause a large rise in rentals, as we would expect during inflationary times. However, we would normally see a "Wage Inflation Spiral" which means that as prices increase, you would ask your boss for a raise to compensate, but then the fact that you are spending makes prices rise again, which then means you ask for another raise to compensate again..... and so the Feds raise interest rates to combat rising inflation.
Amoung prices that are rising, will be Rents. BUT, if you locked in your Borrowing costs, then you will be receiving higher rents but paying the same, allow you to have higher Cash Flow as your reward.
We actually have not seen the Wage Inflation Spiral yet, but we know that in Major Metro areas, we have seen rising rents and values. When the Wage Inflation Spiral happens, multi-family property owners should do fantastic! Just my opinion, however. We can attribute most of the rise in rents and values as probably through increase in population and other economic activities like Tourism. NYC has both and I suspect London as well.
To address the SFH versus multi-family, I look at the multi-family as having the ability to partition each unit as a SFH. I can make any of my properties Condos and at the right time. I just need to develop the skillset to do that and I am working on the for the next several years.
So I will continue to buy multi-family in Major Metros, particularly Brooklyn, but will convert to Condos and sell should Global yields push up Cap Rates and lower multi-family buildings. But obviously, there is a bottom to Multi-Family because you are capable of converting to many SFHs. It will not fall too dramatically unless if SFH also falls dramatically.
Anyway, those are about my thoughts. Hopefully I have not bored any of the readers! I cannot imagine that a reader would have made it this far! At least not without coffee!
- Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes8y
Originally posted by @Anthony Gayden:
Here is a personal example of a property I own. I get both cash flow and appreciation off this property.
$179,000 Purchase Price
$44,500 Down Payment
$5000 closing costs
$29,280 Gross Income (Annual)
-$1229 Vacancy Loss
-$10,140 PITI (Annual)
-$2700 utilities
-$2500 property management
-$5000 maintenance and repairs (approximately)
$7711 cash flow after expenses
So based on my initial investment of $49,500 I got a return of around 15% based on cash flow. Not bad right?
I have owned the property for 3.5 years. It has gained approximately $100,000 in value since I purchased it.
100,000/3.5 = $28,571 per year
So based on my initial investment of $49,500 I got an annual return of 57% based on appreciation alone.
Appreciation came out the clear winner in my personal example. I will however state that I got very lucky there and never planned on making such good gains. Also there is no guarantee that appreciation will continue at the same rate or at all. The market where my property is located is not nearly as dense and restricted as California or NYC but I do expect there to be moderate appreciation in the future.
Sounds like a winner. There are more than few who invest for just for cash flow and appreciation still trumps CF. I guess at a certain IRR point you can decide to hold or sell. Hedge funds run about 60/40 favoring appreciation on the total returns. There was a dude on BP who only invest for cash flow religiously and I get it. When we examined further not a single property made more in cash flow vs appreciation and it was not close either. Now that is what I call a real bonus then.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes8y
Originally posted by @Anthony Gayden:
Here is a personal example of a property I own. I get both cash flow and appreciation off this property.
$179,000 Purchase Price
$44,500 Down Payment
$5000 closing costs
$29,280 Gross Income (Annual)
-$1229 Vacancy Loss
-$10,140 PITI (Annual)
-$2700 utilities
-$2500 property management
-$5000 maintenance and repairs (approximately)
$7711 cash flow after expenses
So based on my initial investment of $49,500 I got a return of around 15% based on cash flow. Not bad right?
I have owned the property for 3.5 years. It has gained approximately $100,000 in value since I purchased it.
100,000/3.5 = $28,571 per year
So based on my initial investment of $49,500 I got an annual return of 57% based on appreciation alone.
Appreciation came out the clear winner in my personal example. I will however state that I got very lucky there and never planned on making such good gains. Also there is no guarantee that appreciation will continue at the same rate or at all. The market where my property is located is not nearly as dense and restricted as California or NYC but I do expect there to be moderate appreciation in the future.
Great property...brilliant. Please don't let my next comment detract from that...it's just a math comment. The cash flow return is 5% (rather than 15%) going forward (unless you refinance). ROI is useful for pre-acquisition return calculations and it becomes obsolete after that in many cases.
I'm going to borrow an analogy from a prior active BP member. The math behind cash flow vs appreciation can be viewed like a teeter totter. As the appreciation return rises, the cash flow return can go down (and vice versa). And you can sit on the whole length of the teeter totter, not just the ends of it.
- Rental Property Investor · Los Angeles · Member since 2015 · 32 posts · 8 votes8y
Hi @Llewelyn A., thank you again for a very detailed response! There's a lot to think about here and I've already re-read the post a few times!
To your question on 30yr mortgages in London/UK: they don't exist, at least not in the standard residential mortgage market. Here few people even go beyond 5yr fix. As a result there is a very strong feedback loop of rates policy to the economy here via the housing/mortgage market.
Long dated fix mortgages are one of the attractions of US real estate for me. I think your point about the power of buying a property, choosing one that will at least appreciate with inflation, using the lender's money at a low fix rate for 30yrs, is underappreciated by many. So I totally agree about the benefit of focusing on growing major metros. Elsewhere I think there can be too much uncertainty as to whether house prices will keep pace with inflation.
@Russell Brazil I liked the way you put this earlier.
Why is it no one doubts that inflation happens yet so many are skeptical when we call the same economic force appreciation?
I'd maybe just qualify it to say that over the medium/long term one should be able to bet on appreciation (provided there is inflation) for all US housing stock in total, but of course that doesn't mean it holds in all individual markets (back to @Llewelyn A.'s example of his friend Steve!)
- Rental Property Investor · Los Angeles · Member since 2015 · 32 posts · 8 votes8y
I need to give the SFH vs multi-family more thought. I can see that if you can convert your multi-family to condos that gives you great flexibility/ a hedge to the two markets moving out of sync. I heard one BP podcast from somebody profitably doing this in CA. If anybody has links or thoughts on how I can learn more about this subject that would be great!
Could be an important factor as I weigh up strategy/market (e..g maybe some cities are much more restrictive about doing this, building code, zoning etc)
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