How Much of a Rental Deal Should Depend on Appreciation?

Question

Here is a hypothetical I see newer investors wrestle with:

A rental costs $400,000 and produces roughly break-even cash flow after realistic expenses and reserves. The loan amortizes each month, and the market has appreciated over the last several years. The investor expects a long hold, but the projected return still depends heavily on future appreciation.

Assume the deal has:

• $2,800 monthly rent

• little or no initial cash flow after vacancy, repairs, management, taxes, and insurance

• a fixed-rate loan

• enough reserves to handle normal surprises

• a five-to-seven-year expected hold

The tension is that appreciation can create substantial wealth, but it is also the least controllable part of the underwriting. Principal paydown helps, yet it does not refill the operating account when expenses rise or a property sits vacant.

One stress test is simple: if the property's value stayed flat for five years, would the cash flow and principal reduction still justify the capital, risk, and management time? If the answer is no, appreciation may be doing too much work in the analysis.

For investors who have owned through different market cycles, how much of your expected return are you comfortable assigning to appreciation when you buy?

Jay Hinrichs · Answer

the issue is an I have not seen it raised on this thread by very sharp investors..  Is this:  No appreciation your STUCK even if your cash flowing a little bit that little bit just does not add up to much of anything unless you have ALOT of units or doors as the BP members like to call them.

and when burnt out landlord syndrome strikes which it does and it will.. exit is painful without appreciation  your going to lose major money your going to lose transaction costs of 7 to 10% of gross and your going to have a HUGE TAX bill in the form of depreciation RECAPTURE again no one talk about that part of the equation. And especially if you did a cost seg on it..  so the only way out is to get on the 1031 Hamster wheel on reinvesting but if your already suffering from burnt out land lord syndrome that may not be an option..  Bottom LINE NO appreciation potential etc  its not a deal I dont care if it cash flows..

V.G Jason · Answer

If you're not betting on appreciation, why even invest?

If anything, market stagnation is your window of opportunity. You don't buy into the midst of a rally; the ideal time to accumulate is during the correction or the stagnation phase. Ideally, you catch the last quarter of it, but since nobody can time that perfectly, you manage the risk up front.

You buy now, put enough down so the asset sustains itself to make it 1.25-1.33x DSCR(so 30-40% down, not this dogmatic 20% bullshit which rules out 98% of opportunities), hold deep reserves(above the line cost so yes negative carry), and focus strictly on properties with strong extrinsic qualities --premium location and/or value add.

By claiming appreciation isn't the thesis of investing, you are effectively betting on a perpetually stronger dollar (deflation) and assuming you're buying poor locations. Real estate requires a 7-to-8-year minimum hold, but ideally, it's a 12-15 yr+ game. If someone wants to take the other side of that macro bet over a 15-year term-- go for it. You will get destroyed.

Dan H. · Answer

I have participated in local tax deed auctions a few times (maybe 4 times) but have not in at least 7 years (maybe 8;years).   Our process is broken.   It is online.You start with a huge list of properties.   You narrow it down to a manageable number of properties.  You then start researching the properties and you will see some strange things.  Here is a partial list of items I have seen- a land locked house that appears to have been using an unauthorized access road across another property.   The other property must have got tired of the illegal access as a huge pile of debris was spread across the road.   A drone was handy on this one (and quite a few others).- a property that when I got to it I was shocked that the property could hold a house.  It was steep.  Pulled out the drone.  The house was on the longest stilts I had ever seen a house on, but this is not the end of this story.  The slope terminated at highway 163.   I had driven 163 numerous times and never noticed the stilts or the house that is almost directly above the freeway.- An attached property that the right side was delinquent.   The left side unit was one story taller than the right unit and had a door onto the right side unit roof with outdoor furniture, fire pit, etc.   I suspect they were owned by the same person or minimum very good friends.   I also assume a new purchaser likely would not want the neighbor to treat their roof as the neighbor’s outdoor space.After this the initial list is paired down more for various reasons.   Then the properties that you have spent time starting to vet start getting redeemed and removed from the auction.  Much of your due diligence is simply wasted.   Finally the auction starts.   Maybe you still have candidate properties to bid on.  You have no contingencies, no inspection, never been in the unit.   You need to account for these risks.  The property typically ends up selling for more than you would have offered cash only no contingencies on the mls.Why?  I have some theories:- some bidders have inside info.   They may know the previous owner and know it is not thrashed on the insure and that the mechanicals are in good shape.- inexperienced investors get caught up in the exuberance of the auction.- inexperienced investors that undervalue the risk and the value of cash offers.We have bid on a few properties.   Never won the auction and only once came slightly close (usually we are not close).I understand some areas allow redemption long after the auction.  Not sure how that would work.   Have to wait until redemption period expires before adding value?Virtually every year I see a post on the local tax auction.   I reply with my view and ask them to let me know if their experience matched my description.  No one has ever let me know one way or the other.   It is my belief my description is still accurate.

In CA, sb1079 has passed since I last participated in an auction.   Make sure, especially if not bidding to OO, that you understand any potential impact.   I have not done full research on sb1079 to know if tax auctions are excluded.   It would suck to win the auction, start work, and have a preferrred bidder purchase in the sb1079 redemption period.

Good luck

Diana Khan · Answer

@Dan Handford, this is something I think about a lot when looking at real estate.

For me, appreciation is great, but I do not want to feel like I need it just to make the deal feel okay.

If I owned the property for five years and the value barely moved, I would still want to feel comfortable with what I bought. Is the rent covering the property? Am I building equity? Do I have enough room for repairs, taxes, insurance, or a slower rental period?

I’ve learned that the deals that feel best are usually the ones where I am not checking the market every few months hoping the value went up.

If appreciation happens, great. But I would rather see that as extra upside than the reason I bought the property in the first place.

Michael Eskenasy · Answer

A lot, potentially. I just don’t think appreciation should be allowed to rescue the underwriting.

If I buy a property specifically because I believe an area is going to outperform over the next 10 years, appreciation is obviously part of the thesis. Pretending otherwise doesn’t make the analysis more conservative; it just makes it incomplete.

But I’d separate “why I want to own this asset” from “what keeps this asset alive.”

Cash flow and reserves keep it alive. Principal reduction slowly increases equity. Appreciation is where you can get disproportionate upside, but it’s also the variable you have the least control over.

So your flat-for-five-years test is a good one. If values stay flat and I’m merely feeding a property every month waiting for the market to bail me out, I probably didn’t buy a rental. I bought a leveraged appreciation bet with a tenant attached.

That can work spectacularly.

It just needs to be called what it is.

Henry Lazerow · Answer

It depends on the market. In cities that have very low added inventory with strong employers located there you can expect prices to appreciate past inflation. North side Chicago, San Francisco, etc. Even with rates up the north side Chicago properties are selling 5-10% yoy and rents seeing double digit growth.

Pro development cities with easily added supply like Austin Texas for example or any random city it’s a gamble to expect sustained appreciation past inflation rate as added supply drops prices.

For depressed cities like Detroit MI, Gary IN I could see them having long term appreciation below inflation. Right now these places pumping as investors desperate for yield but doubt is sustainable.

V.G Jason · Answer

It should be thesis of the entire investment.

Without appreciation, risk-adjusted returns on real estate or any physical asset is not worth the hairy situations it puts you in.

Cash flow is simply just a baseline survival mechanism; if you're breakeven you're actually sinking. 1.33ishx DSCR  is survival, 1.75-2x is real investing, going over 2x is where you start understanding things better.

Appreciation is not just the equity building, but the rent appreciation which helps your DSCR-- do not forget that. Land, scarcity and value adds are the key to it. Almost all three need to be in the deal, but at minimum 2.

This same convo happened with our old friend Cleveland Bob on this forum. He was a flipper, and kept telling people cash flow, cash flow, cash flow naturally as a Cleveland-seller. Someone asked him his biggest regret-- he said selling , and he would've made a ton more if he would've held onto properties. I clarified his biggest regret was then appreciation...not the cash flow he keeps touting.

Ryan Thomson · Answer

Zero. If I can't defend the deal on cash flow plus principal reduction alone, appreciation is gravy, not the thesis.

The flat-value stress test you described is the right one. If the answer is "no, we'd be underwater" that's not an investment, it's a bet on the direction of a market nobody can predict. Plenty of Colorado investors made that bet between 2012 and 2022 and got rich. Plenty of San Diego investors made it in 2005 and didn't.

On a $400K break-even deal you're probably banking on $11-14K in principal paydown per year depending on rate and term. That's real, but it doesn't cover a $6,000 HVAC replacement or three months of vacancy. The returns look good on a spreadsheet and miserable when you're writing the check.

The way I've been solving this is specifically looking for assumable mortgages instead of accepting current-rate financing. A $400K home with a $340K loan at 3.0% carries around $1,433/month principal and interest. That same $340K loan at 6.9% is $2,250/month. The $817/month difference flips a break-even deal into something that actually cash-flows, and suddenly you're not hoping the market does anything — the numbers already work without it.

If you're stuck underwriting deals at today's rates and keep landing at break-even, it's worth asking whether you're solving the wrong variable. The rate is often more fixable than the price.

Igor Ganapolsky · Answer

@Dan H. — your CA tax deed experience tracks. The landlocked parcel with the debris road, the house on stilts over the freeway, the attached unit with the shared roof terrace — those are the kinds of things you can't see from a folio number. And the redemption problem is real: spending hours on due diligence only to watch properties get pulled before auction is a terrible ROI on research time.Florida's process is different in one critical way that matters for your "waiting until redemption expires" question — there's no post-sale redemption period here. When the tax deed sells, the prior ownership chain is wiped. You get a new deed. That's what makes the FL auction viable vs CA's structure where the clock doesn't start until redemption clears.Your point about auction exuberance driving prices above what a cash offer would get on MLS is the real risk in any market. The bidders with inside info who know the unit isn't thrashed and the mechanicals are solid — they have an edge that pure spreadsheet analysis can't touch. I've seen it here too. The guys who've been doing Broward auctions for 20 years know properties that casual bidders wouldn't touch.Where I think there's an edge is pulling comps BEFORE auction day so you know the ceiling, then only bidding when the spread justifies the blind risk. If a property is assessed at $400K and comparable sales on the same street closed at $420K-$450K in the last 6 months, you know your exit price before you bid. You're not speculating on appreciation — you're capturing the gap between the tax-assessed value and what the market actually pays.But I'll concede your broader point: if you can't get inside the unit, you're pricing in a risk premium that often eats the spread. The ones who do well at tax auctions have either seen the inside or have enough deals that they can absorb a few duds. I'm in the second camp right now — building the analysis system so at least the math is right before the bid, even if the physical condition is still a gamble.

Dave Meyer · Answer

Market appreciation (as opposed to value-add, which is a different story) should be treated as a potential return-boost that will likely come one day, but isn't guaranteed. The median home price charts most people cite hide the reality of appreciation, that 'real' (inflation-adjusted) appreciation is a regular feature of the housing market, but it's not linear, and is more a stair-step function. https://fred.stlouisfed.org/series/QUSR628BIS

So, IMO, the game is to get a deal that works and funds itself so you can stay in the game to enjoy the return boosts that come when real appreciation hits. No one knows when that will happen, so you need a combination of cashflow, tax advantages, amortization, and value-add appreciation to maintain the deal and earn a good return while you wait.

I think in the coming years counting on market appreciation is foolish. The data shows we're in for stagnant or declining home prices for the foreseeable future (unless the gov really turns on the money printer again, which could happen, but also could backfire). So, buy under current comps, rely on value add appreciation and cashflow more heavily now. Then, sometime in the future when market forces push prices up in real terms again you look like a genius.

How Much of a Rental Deal Should Depend on Appreciation?

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