When real estate investors talk about appreciation they are talking about the tendency for real estate to go up in value over time.
Real estate prices can rise and fall over time, but real estate investors often believe that over long periods of time real estate tends to increase in value.
There are definitely real estate markets where prices have not gone up. In fact, there are real estate markets that have gone down over time.
However, if you look at charts of the United States national real estate prices over long periods of time, the trend before the dip in prices in 2008 has been an annual rate of increase of between 6 and 7% per year.
There are many factors that can cause real estate prices to rise over time including supply and demand. House prices tend to rise as the demand for those houses is strong. House prices tend to drop as the demand for those houses is weak.
Inflation, or the overall value of a dollar, can cause prices to go up. If a dollar, over a period of time, is worth half as much then the price of housing will tend to be about twice as much.
Often related to inflation is the cost to rebuild the same property. The cost to build a property can affect its value.
Interest rates can affect whether real estate prices appreciate or decline.
Until my next post,
James
P.S. Successful real estate investing is done with teams… take your real estate investing business to the next level with our Real Estate Investor Bronze Membership and add me to your team.
When I discuss in other articles some of the benefits of investing in real estate – like appreciation, depreciation, leverage and equity build-up – I often assume that you will have break-even cash flow. But is that realistic?
Well, yes and no.
First, let’s define what determines cash flow for a property. Cash flow is the difference between income from the property – usually rent – and expenses on the property. Expenses usually include taxes, insurance, management, maintenance and any debt payments. While taxes, insurance, management and maintenance can vary a little, what is largely within your direct control is the amount of the debt payments. How so?
Well, you control how much cash you put towards the purchase and how much of the purchase price you finance. If you put more down, your payments will be less. If you finance a larger amount, your payments will be more and you are more likely to have negative cash flow. If you look at negative cash flow as a function of down payment, you could think of negative cash flow as a deferred down payment that you are making over time.
So, can you assume that you will have break-even cash flow? Most people would argue that unless you are putting a large amount down, you are likely to have negative cash flow on a property when you first buy it. I would tend to agree, but what happens over time as rents go up? Well, you have some expenses that rise too – like taxes, insurance, management and maintenance… but usually the largest of your expenses on your property is still your mortgage payment. If you have a fixed mortgage payment, you should see an increase in cash flow over time.
So, while you may have negative cash flow when you first purchase a property, you should see significant positive cash flow as rents tend to rise over time. That is why I feel very comfortable making an assumption that your property can have break-even cash flow over a 30 year period when looking at the other benefits of real estate investing. It is a way to simplify the discussion to see how one benefit looks.
Of course, if you want to see how all the variables interact, I strongly encourage you to try the investment simulator game. You can try various real estate investing strategies in a fun interactive game format to see exactly how income and expenses can change over time and how they affect your investments and net worth.
Until my next post,
James
P.S. There are some great strategies for overcoming negative cash flow through creative deal structuring that we teach to our Real Estate Investor Bronze Members in our training materials and consulting sessions. Sign up today to learn those strategies and have us analyze your deals with you to create positive cash flow for you in your real estate investing business.
I am constantly reading books on real estate investing, marketing and other similar topics that interest me. Right now I am reading Warren Buffet Wealth by Robert P. Miles. In the book, there is a section where Warren Buffet addresses compound interest. He poses a hypothetical scenario, where if Queen Isabella, instead of investing $30,000 in Christopher Columbus’ scheme of charting a new passage to Asia, had invested in anything else that provided only a 4% compound rate of return, she would have made $2 trillion by 1963. In 2003, her investments would have been worth $9.6 trillion, which, according to the author, is more than the value of all the publicly traded stocks in the same “new world” that Columbus stumbled upon some 500 years ago.
Why am I sharing this with you? Because one of the benefits of investing in real estate is the compounding effect that comes from long-term appreciation. Let me explain.
To make the discussion easier, let’s make an overly-simplified assumption. Let’s assume that all the income you receive from your rental property exactly equals all your expenses for that property. In other words, we will assume that there is never any positive or negative cash flow. For our discussion, the house always has break-even cash flow.
If you purchased a house for $100,000 where all the income from the property paid for all the expenses of the property, what happens to the value of that property over time?
History has shown that, despite short-term downward fluctuations, real estate tends to go up in value over time. In Warren Buffet’s example, he used a 4% compound rate of return. Historically, real estate has gone up between 6% to 7% per year, but let’s use Warren Buffet’s 4% growth rate for this exercise to keep our numbers conservative.
If the value of your house were growing at 4% per year, what would the house be worth when you paid it off in 30 years? It would be worth approximately $311,865. At the 30 year point, when your mortgage has been paid off, you will also have a nice monthly income from the property.
This appreciation is one of the things that attracts investors to real estate as a long term investment. If, in 30 years, when you are preparing to retire you want to have a certain amount of money, you can calculate how many houses you need to purchase this year with break-even cash flow to achieve that goal.
For example, if you wanted to end up with $2 million in net worth 30 years from now and you think real estate will be going up in value by 4% per year, then you would need to purchase approximately $642,000 worth of real estate today. If houses in your area are $100,000 that would be about 7 houses. If houses in your area are $200,000 then that’s about 4 houses.
Use your own numbers to determine how many houses you need to purchase in order to achieve your own financial goals.
Until my next post,
James
P.S. We have some great tools for our Real Estate Investor Bronze Members for determining and setting goals in the Real Estate Investor Wiki. Be sure to check that out if you are a member and if you have not yet signed up to get access to all our training materials including over a hundred real estate courses and on-going live training plus free consulting then what are you waiting for? Sign up now using this link!
