3-6%+ Avg Appreciation Forever?!? Maybe!

18 Replies

How can people pay ever-increasing prices that exceed their income growth (buying or renting)? Why wouldn't they just build somewhere else? Before anyone hurls rocks at me!.. Here's the premise:

High-demand areas and changing neighborhoods can allow for elevated long-term increases in rents and prices that consistently and significantly exceed national, or even local trends in income increases. Phenomena such as gentrification can allow for this long-term "outpace" trend - because tenants aren't paying more of their income - it's a different tenant with more income, who moved from an even more expensive place!

I don't COUNT on this for the deals to work, and make good cash flow returns on my property (and LOTS of appreciation so far). But I don't think it's a crazy idea for this to happen, on average, over the long term in my area. I own several apartment units and houses in some of the most affordable (low-income) areas in the San Francisco Bay, within a 35min commute to SF and close to Oakland. Any buildable land at a reasonable cost is more than an hour away from most employment centers (each way). There is lots of spillover from local areas that are priced at multiples of these areas.

So is this a crazy idea? Can average rents and prices outpace increases in median incomes (nationally or locally) for a lifetime? (this leaves out the question of the MIX in buyers). Thoughts? Criticisms? (while being civil please!.. I know "coastal" ideas, that depart from conventional cash-flow-at-purchase thinking, can ruffle feathers on BP!) And of course, with about 30% leverage, 3-6% asset returns would be about 9-18% return on equity..! IF it happens..

On a macro level, it's really more of a political thing...the rich getting richer. Forget the dreaded "top 1%", that's a straw man. But what about the top 5% or 10%? There is a persistent segment of the population that is going from middle class to upper middle class (if you will), and that is driving the bulk of gentrification in places like the Bay Area, costal CA , Hawaii, NYC, etc.

My prediction is that this wealth gap will grow further in the next two years, but if our economy tanks again, or we hit real inflation, you can expect social unrest, cause I sense a sh*t-storm brewing from my vantage point here in SF, with all the protests about middle class people getting priced out. Once that starts effecting other areas in the country, we're heading towards uncharted waters IMO.

So increasing values, gentrification, new wealth have all benefited my investments tremendously, but I'm wary of the prescient biting the hand that feeds due to a nasty backlash. As the Chinese are apt to say, may you live in interesting times!

Interesting thought, and I've wondered the same thing over the past two years. In my area, we've also experienced silly appreciation and rental increases. I've thought long and hard about it, and talk with other local investors.

My conclusion is that it IS realistic for continued price and rental increases for a few reasons: no buildable land, increasing population, a booming tourism industry, foreign buyers paying cash well over market value, and one of the only places on the island with great beaches, decent schools, and a real hospital.

To test your theory, look at how your market performed 2007-2010. Mine dropped about 5-10% at most, but demand was still high.

J and @Amit M.

I don’t know about 6% annual appreciation, but 3% - 4% is very doable going forward in my opinion.As you know, the SFBA is home to over 7 million people.Based on the 2013 population report from the California Department of Finance, the Bay Area is the only region in California where the rate of people migrating in from other areas in the U.S. is greater than the rate of those leaving the region.

San Francisco is surrounded by water on three sides. The city squeezes over 800,000 people in 47 square miles making it the most densely populated major city in North America after New York City.

South of San Francisco is the Peninsula and the South Bay, aka Silicon Valley, which is home to many notable tech companies like Apple, Google, Yahoo, Facebook, Oracle, AMD, Adobe, Intel, Netflix, Cisco, HP, EBay, Marvell, Altera, Ericsson, IBM, Hitachi, Kaiser Permanente, KLA Tencor, Qualcomm, Quantum, Xilinx, Tivo…… I could go on and on, but you get the picture. I haven’t even mentioned many other start-up companies that are worth billions and tens of billions like Square, Pinterest, Twitter, Linked-In, Go-Pro, etc. If you add up the market cap of these companies, they’re in the trillions. My point is that there's tremendous wealth in the Bay Area.

Since the 1980’s, the Bay Area has experienced rapid growth. To limit urban sprawl, planned communities were laid out to control growth. The purpose was to protect the remaining open space from development. Yeah, there are a lot of NIMBYs in the Bay Area. Therefore, most new growth has been in-fill development in the form of high density housing.

The old saying “cashflow pays the bills; appreciation makes you rich” has ringed very true for the Bay Area. With limited buildable land, high appetite for real estate from the locals and foreigners, and many new millionaires from start-up companies, appreciation is almost a guaranteed. Again, it's just my opinion.

@Bob Bowling , did I get it right, or am I too conservative with my appreciation estimate?

When I first set out in RE investing I too thought cash flow is all that matters. And then I read the book "Equity Happens" by the "Real Estate Guys" and my view changed completely. It so happens that the two "Real Estate Guys" hail from San Jose. So that makes sense.

What the book preaches is that there are two stages to investing. The first stage is building up your equity. Only after you got big equity-wise do you switch over to cash flow so you can live off that in retirement. It's not just hand waving on their part. They do go over some math that's fairly convincing in my mind.

SF Bay Area is in the same league as NYC in my opinion. It will always be expensive and getting more so every year. Limitation of buildable land is one thing. But the NIMBY'ism and the anti-growth element is a much bigger deal. The Bay Area core just doesn't have the stomach to go high density, so RE price has no way to go but up.

5% annual appreciation for the next 20 years is very likely IMO.

Interestingly enough, I wonder what will self-driving cars do to local RE. If I can just sit in a self-driving car napping or whatnot I won't mind commuting to Tracy.... Sci-Fi? Maybe. But you never know. :)

Originally posted by @Minh L.:

@Bob Bowling , did I get it right, or am I too conservative with my appreciation estimate?

1% in appreciation can mean a HUGE difference over time. Let's pick 1978, the year Prop 13 was voted in and the year of my first purchase. SF proper nice SFH at $60,000. At 6% appreciation that would sell for $489,000 today. I'll buy ALL you got at that price. Now let's look at a more realistic appreciation rate of 9%, compounded. That would put that same $60,000 property at $1,335,000.

I actually posted a study I did on another forum documenting 12% appreciation of a bunch of condo's with last sales in 2008 & 2009 that so infuriated a few of the OLD members that they got together and had me banned. Kill the messenger! Better for each individual to figure their own appreciation rate. I'm not trying to convince anyone of anything except to run ALL the numbers.

Any other RICH old geezers wanna talk appreciation I'll be on Alaska Airlines from Honolulu to Oakland 1:50pm. Come on up to first class and say Aloha! ;-P

@Amit M.

I think you make a great point. The market will probably sustain continued levels of rent and appreciation increases that outpace median income growth. But at what point do the people and politicians step in to put their foot down, and say “enough is enough.” Then implement even crazier rent control in SF (or god forbid, make condos subject to!)

I’m totally on the same page with you. I want increases to be good/great, but the further that gap widens, the more likely it is that politicians step in to control it. My properties are in Richmond right now, and I LOVE all the increased rents, but if it is too high for too long for too many, there will be backlash. I consider the possibility of rent control in Richmond at some point, if rents keep increasing at this pace.. There has been talk for 20+ years. When? Don’t know. But the higher rents increase YOY sustained, the bigger the possibility of backlash, IMHO. Lots to be made 'til then though!

@Minh L. , I like your run-down of the circumstances with the Bay, and especially Peninsula w/ the high tech. Crazy growth. And these are much more solid companies than the 2001 days... But will we see a 2002? Probably some time, I think. Shake-out of tech companies without fundamentals. General drop in tech. But from RE side, mostly decreases in office rents/values, and to some extent in rents and values on residential not crazy... tough to call though... Could run for a long time..

I think you and @Manch Hon have a great point I did not bring up about NIMBYism and anti-development. It's not just the limited land, increasing income in certain segments, and windfall capital from high tech.. Any increased density or development is fought with tenacity! Bad for new construction, but great for existing owners!

Originally posted by @Bob Bowling... Any other RICH old geezers wanna talk appreciation I'll be on Alaska Airlines from Honolulu to Oakland 1:50pm. Come on up to first class and say Aloha! ;-P

I love it Bob!!!
IF you can afford to come talk to me with your CF! lol

To be honest, I'm big on both. I love and eat up cash flow in my lower-income neighborhoods in the Bay, but building up square footage and overall leveraged RE asset exposure is important to me too. $10/sqft adds about $50K to my equity right now, and growing.. And $10/ft is not a big difference in this market.. It would take YEARS to get that amount of return on CF, even in "high CF markets." And I'm getting good CF returns anyway, on top of it..

And Aloha!

I agree with everyone's comments here so far. What creates the whole 'appreciation mystique' is that it is highly complex, and dependent on local and global influences. There's local effects like the tech industry, NIMBYism, limited growth, area desireability, etc. Add to that macroeconomic policy, globalization trends and politics, and you have a fun, and never ending quest trying to sort out all the variables!

Right now in SF there is a lot of political backlash due to the lack of affordability. SF may be a beacon for things to come in other cities and regions if the economy continues to expand...although economic results have been highly mixed. Quite frankly I wouldn't be surprised if other cities in the Bay Area start adopting rent control measures. While that will freak out many investors, it will also create opportunity for others, who know how to work (and make money) with rent control.

I have personally become fearless WRT all the political activism happening here. I know that the more distortions politicians throw into the mix, the more opportunities there are to make money, if you know how to maneuver 'the system.' For instance, with more rent control restrictions, there are now many property owners who are renting units only as short term corporate, vacation, etc. There are also more owners who are wealthy enough that they can afford to keep units off the market by leaving them empty! It is belived that there are at least several thousand vacant by choice units in SF. These responses by property owners to ownerous rent control measures actually cause current market rents to be even higher! The idiots at city hall don't get that; the more restrictions they put on housing, the more housing becomes expensive. And when you have natural turn over in a unit, it's literally a party for the landlord!

So there are many factors that contribute to the substantial appreciation in the Bay Area, and SF in particular. And investors who dismiss appreciation as pure speculation or just an added 'nice to have' bonus, are not taking a critical look at the myriad of factors that make appreciation a very real thing.

I think appreciation is like tooth fairy for middle America. You look at cashflow-mecca like Dallas and you see appreciation that barely keeps up with inflation. That skews people's views.

It may be an offbeat opinion but I feel super fortunate to be in the Bay Area RE market. People complain about high house prices and tough competition but I see opportunities very few others have.

Originally posted by @J Martin rtin rtin tin:
Originally posted by @Bob Bowling... Any other RICH old geezers wanna talk appreciation I'll be on Alaska Airlines from Honolulu to Oakland 1:50pm. Come on up to first class and say Aloha! ;-P

I love it Bob!!!
IF you can afford to come talk to me with your CF! lol

And Aloha!

Yes, just me and the young trophy wife, err..Morgan Fairchild, Yeah, Morgan Fairchild, that's the ticket. I cringe to think how many here have to Google that.

While I was investing I used my cash flow to buy ANOTHER non initial cash flowing property. And another. etc. Now I'm reaping the rewards of my delayed gratification and spending BOTH appreciation and cash flow/.

J let's put your 3%-6% into perspective just a bit. I just recalculated my parents first purchase in 1968 for $16,000. Bi-level in northern Kentucky/Cincinnati metropolitan area. Today that appreciation rate has been 4.9% Selling at just under $150,000. I calculated that a few years ago and it was about 5.5% which would mean that it would have to sell for about $188,000 today. I think that the local market has not fully recovered so I would say a 5% or better appreciation rate is typical of Cincy.

Now that same $16,000 purchase in a 9% appreciation area would have a market value of about $843,000! Of course you probably couldn't find a $16,000 property in SFBA but maybe $20,000 $30,000. Might be worth a little sacrifice for a few years.

So, what is a typical flyover appreciation rate?

@Amit M. , I think you need to make that a whole new topic, and tell the BP world what's going on! Spot on! I'm in contract on a 4plex in Oakland that has 3 vacant units right now, so I'm going to side-step the rent control issue for now.. but will definitely be chatting with you as always at our meetups in the future!

@Bob Bowling , I like your "actual" calculations from your properties in days past.. It's quite phenomenal. That's why I love leveraged exposure to RE!!!

12-20% ROE just from appreciation over the long term! And again, I'm already getting good CF.. I love it :)

@Manch Hon , the more I buy, and the more I look, the more I like the long-term prospects here... It is a great place! @Minh L. , Amit, and many others will confirm that for you!

Okay, lets take some real case scenarios. Lets say you have 150K to invest today. You have two possible scenarios

1. With $150K I could buy 10 $50K homes that have enough cash flow to pay off the mortgage plus expenses in 10 years. In that scenario I have gained $350K in equity over 10 years assuming zero appreciation.

2. I buy one condo for $500K in the Bay Area. The rent will barely cover the PMI + HOA + maintenance on a 30 year loan. I can assume zero vacancy in the Bay Area due to high demand. In 10 years the principal pay down would be approximately $70K. So the equity value has to go up by another $280K (or over 50%) to match the returns. Can that happen? Well it depends on which time period you look at. I have owned two homes in the Bay Area.

Home 1: Bought in 1998 for $340K. Value in 2004 $800k. Value in 2008/2009 $650K. Now probably back to closer to 800K. This would have been a great investment under any circumstances.

Home 2: Bought in 2007, $620K. Value in 2008/2009 $580K. Value today: $700K.

Both my Bay Area homes are primary residence purchases so I did no calculations prior to buying. And if I move out from my current home I would most likely rent it. But I dont think I would buy my home today for $700K as a rental investment if I didnt already own it.

@Bob Bowling I like your $16,000 starting figure, as that is the exact number I started my "investing career" (although I didn't know it at the time) back in 1994. Back then I was a kid working hard in tech...in the days when Sun Micro, SGI and HP were cool companies...yikes! My grandmother left me $16,000 and I brought a 2 unit bldg in Noe Valley with a friend/partner, my unit for $160,000. Back then Noe was a sleepy little neighborhood (not the über-yuppie-destination it is today ;). Plus the market was real sslllooowwww in '94. We looked for months, and came back to this building because it was so cheap!

Fast forward a decade, and in 2004 I decided to get serious about real estate investing and do it full time. In 10 years time that unit (which I converted to a condo) went from $160,000 to $705,000 when I sold it (I couldn't resist the $500,000 tax free gain.) I had also leveraged and borrowed on that unit earlier to purchase 2 more buildings in SF. I put in maybe $15k to condo convert, so it appreciated from $175k to $705k in 10 years. Plus remember that my initial cash outlay was only $16k. Frankly I'm too lazy to run the numbers again (anybody want to crunch the appreciation rate on that?). But I do remember that it's not too shabby!

@J Martin "I think you need to make that a whole new topic, and tell the BP world what's going on!"

Frankly, I'm of two minds on that. One one hand I do enjoy the intellectual battle, wit, and not to mention somewhat self serving bravado that goes with expounding on your POV. On the other hand, why promote how good your market is? I'm happy that others are fixed on fly over states. Why get more competition into our markets?

Originally posted by @Amit M. :
it appreciated from $175k to $705k in 10 years. Plus remember that my initial cash outlay was only $16k. Frankly I'm too lazy to run the numbers again (anybody want to crunch the appreciation rate on that?). But I do remember that it's not too shabby! @J Martin "I think you need to make that a whole new topic, and tell the BP world what's going on!"

Frankly, I'm of two minds on that. One one hand I do enjoy the intellectual battle, wit, and not to mention somewhat self serving bravado that goes with expounding on your POV. On the other hand, why promote how good your market is? I'm happy that others are fixed on fly over states. Why get more competition into our markets?

@Amit M.

WoW, about 16% compounded appreciation a year for 10 years. Any idea of its market value today?

I am not encouraging EVERYBODY to invest in SF or Honolulu but to look in their local investment area and take into account the potential appreciation in the various areas and property types. Every town has a wrong side of the tracks. A lot of people can't invest in initial no cash flow properties. And a lot need the cash flow for their salary. AND despite the facts probably 80% will continue to think it's too good to be true and the market will turn any century now! LOL And, there's always room for educated experienced investors. The Johnny come latelys will just help clear out some of the crap and churn some properties for the seasoned investors.

@Anish Tolia ,

Based on your examples above, I saw a couple of things:

1) CA real estate is cyclical. The property that you bought in 1998 has given you a higher return compared to your mid-west buy-and-hold properties.

2) Your 2007 property is worth more than its peak value while those $50k properties in the mid-west are likely still below its peak value. Had investors bought them in 2007, would these properties still performing well?

3) I guess you have probably bought these mid-west properties just in the recent years. As @Jay Hinrichs mentioned in another thread, I guess it's fair to say that you're still in the honeymoon period (3-5 years). We will have to wait after the honeymoon period is over before we can compare the true cash-flow with the Bay Area appreciation. I haven't invested outside of the Bay Area so I have no dog in this fight.

4) Timing is so critical to one's success in real estate investing.

Have a great weekend everyone.

@Bob Bowling "I am not encouraging EVERYBODY to invest in SF or Honolulu but to look in their local investment area and take into account the potential appreciation in the various areas and property types. Every town has a wrong side of the tracks. A lot of people can't invest in initial no cash flow properties. And a lot need the cash flow for their salary. AND despite the facts probably 80% will continue to think it's too good to be true and the market will turn any century now! LOL And, there's always room for educated experienced investors. The Johnny come latelys will just help clear out some of the crap and churn some properties for the seasoned investors."

Yes, I second that completely. There are varying degrees of appreciation in most areas, and analyzing that is important, in addition to calculating cash flow. And yes, most people can't afford to buy in our expensive markets. The exception are out of town people that are already wealthy, and they mostly look to park their cash in appreciating markets. But usually they are not active investors, adding value, going into gentrifying neighborhoods, etc. They usually like to buy newer condos in secure condo towers near downtown. And depending on their timing, and their leverage (or lack of if buying all cash) they may do well or they may just do okay. I'm always much more active: repositioning properties, expanding, lot splits, refinancing/leveraging, renovations, buying out low rent tenants, condo converting, sussing out up and coming neighborhoods, etc., etc. When done well it all reflects on my returns.

BTW, I'm guessing that noe condo would go for minimum $800k today, maybe closer to $875k.

Minh L. Fully agree. The first property return was fantastic. 1998 was the ideal time to buy. 2007 was the peak of the cycle and not the best time to buy. That's the point I was making. Bay Area investments returns depend on timing and there is risk. Of course over a long enough period you can't really lose but my horizon is 10 years.

You are right that I am in the Midwest properties for less than 3 years. But my financial models are conservative and account for capital reserves so hopefully I will be close to predicted returns. I am also building a portfolio so averages should apply better thank single home.

I figure I am already exposed to Bay Area Re with two homes. So l am trying another approach as well. I am all about diversification so even in Re I am trying different things like out of state rentals, private lending, tax liens etc.

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