Understanding Appreciation – A Guide to Becoming Wealthy with Real Estate for Nomads

This is the class I presented on September 22, 2016 in Fort Collins, CO on appreciation. The outline and additional resources are located below.

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Watch the recording of the live presentation of "Understanding Appreciation – A Guide to Becoming Wealthy with Real Estate for Nomads" available on:

https://learntoberich.com/understanding-appreciation-a-guide-to-becoming-wealthy-with-real-estate-for-nomads/

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Appreciation Classes Understanding Appreciation

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Read the "Net Operating Income" blog post on

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Net Operating Income Understanding Appreciation

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Return On Investment Understanding Appreciation

Introductions

During the introductions, I asked the following:

  • Who are you?
  • How long will it take a $250,000 property to be worth $1,000,000 in our local market?
  • BONUS QUESTION If you put 20% down ($50,000) what is your average return on investment per year once it gets to $1,000,000?

Upcoming Classes

I think talked about the upcoming class schedule.

What is Nomad?

I then covered What is Nomad? and moved into the main part of the presentation.

Wealth

  • This presentation is called “A Guide To Building Wealth”
  • What is wealth?
    • an abundance of valuable possessions or money.
    • the state of being rich; material prosperity.
    • plentiful supplies of a particular resource.
    • Rich Dad’s definition of Wealth:
      • The definition of wealth is the number of days you can survive without physically working (or anyone in your household physically working) and still maintain your standard of living.
      • For example, if your monthly expenses are $5,000 and you have $20,000 in savings, your wealth is approximately four months or 120 days.
      • Wealth is measured in time, not dollars.
    • So, using Rich Dad’s definition there are two ways to build wealth:
      • Cash Flow and/or
      • Appreciation
        • To “use” appreciation, you need to:
          • Refinance and pull cash out, or
          • Sell the property
            • This might be Lease Option exits for Nomads

What do you call it when you buy something hoping that it goes up in value?

Speculation.

So… isn’t that what appreciation is?

Yes.

The exception being “forced appreciation”… buying properties below current After Repair Value (ARV) like we discuss with Fixer Upper Nomad.

Which ones of these are speculative?

Assumptions Without Leverage

  • $200K house with $200K (100%) down
  • Full Net Operating Income as cash flow
  • 3% appreciation rate means 3% return
  • No return from Debt Pay Down because you don’t have a loan

IMPORTANT NOTE: Leveraging with 20% down payment increases returns by 5x.

Assumptions With Leverage

  • $200K house with $40K (20%) down
  • $200/month positive cash flow
  • 3% appreciation rate

IMPORTANT NOTE: Leveraging with 20% down payment increases returns by 5x

Assumptions With Nomad 5% Down Payment Leverage

  • $200K house with $10K (5%) down
  • Breakeven or slightly positive cash flow (not counting tax benefits)
  • 3% appreciation rate

IMPORTANT NOTE: Leveraging with 5% down payment increases returns by 20x.

Appreciation Chart Assumptions

The following are assumptions I used when creating the subsequent charts using my 100-Headed Dragon Spreadsheet that I use when using Monte Carlo modeling.

Summed Returns Over Time

A couple things to note about the chart above.

Depreciation First, depreciation drops off after 28 years (with year 28 getting only half the benefit of the other years). For the first 27 years, it is a constant dollar amount.

Appreciation The amount of appreciation is increasing over time. By year 31, appreciation and cash flow are the only two returns that remain since we no longer get depreciation and the loan is paid off so we no longer get debt paydown.

Cash on Cash This is the return from cash flow. It starts off very small, but increases over time. By year 31, it is one of two returns remaining with appreciation.

Debt Pay Down This is the return from paying down the debt on your mortgage. It starts off relatively small (larger than only Cash On Cash), but it also increases over time. In year 30, it goes away completely.

Percent of Total Return Over Time

What is “Normal” Appreciation?

Source: http://www.realestateabc.com/graphs/natlmedian.htm

National Data Summarized

  • From 1968 through 2004
    • My Fort Collins, Loveland and Windsor data is 1996 to present
    • See upcoming slide…
  • From data on previous slide:
    • Average = 6.41
    • Median = 5.85
    • Standard Deviation = 3.30
  • Case-Shiller claims 3.4% annually from 1987 to 2009
  • Another website claiming National Association of Realtors as source claims 5.4% annually from 1968 to 2009

Fort Collins Appreciation by Year 1984-2013

I only have MLS data from 1997 or so on. I found data showing Fort Collins appreciation rates from 1984 (13 years prior to my data) through 2013. The following chart shows their numbers for Fort Collins appreciation for years 1984 through 2013.

The average is 4.04% and the geometric mean is 3.96% for this time period.

Fort Collins and Loveland Appreciation

New Construction 1963-2010

The following show the average of the median new construction price appreciation and the average of the average new construction price appreciation. Plus, the median of the median and the median of the average.

Source: http://www.census.gov/const/uspriceann.pdf

Case-Shiller Index

The price of existing homes increased by 3.4% annually from 1987 to 2009, on average. (Wikipedia) We don’t adjust for houses getting bigger, because the Case-Shiller Index tracks repeat sales of the same homes. (They might get a little bigger from remodeling, but so few of them will get bigger, and by such a small amount, that we can safely ignore that.) The general rate of inflation during this time was 2.9%. So again, the appreciation rate for homes was very similar to the general inflation rate.

Source: http://michaelbluejay.com/house/appreciation.html

Case Shiller Chart with Interest Rates, Population and Building Costs

Source: http://www.econ.yale.edu/~shiller/data.htm

Cash Shiller – A History of Home Prices

Source: http://ritholtz.com/2010/07/updating-the-case-shiller-100-chart-forecast/

Case Shiller Home Price Index

Inflation adjusted. Not seasonally adjusted. Dec, 1890 through May, 2016.

Source: http://www.multpl.com/case-shiller-home-price-index-inflation-adjusted/

US Housing Price Index Since 1900

From 1900 to 2012: Average Annual Home Price Increase = 3.1%/year. Inflation Rate = 3.0%/year.

Appreciation has essentially been inflation.

Source: http://observationsandnotes.blogspot.com/2011/06/us-housing-prices-since-1900.html

Inflation-Adjusted US Home Prices Since 1900

From 1900 to 2012: “100-Year Inflation-Adjusted Housing Price Growth was Less Than 1%/Year.”

It was .1% per year after inflation.

Source: http://observationsandnotes.blogspot.com/2011/07/housing-prices-inflation-since-1900.html

Inflation = Appreciation

US Yearly Inflation since 1900 – 1900-2011

Inflation has averaged 3% per year.

Source: http://observationsandnotes.blogspot.com/2011/03/100-years-of-inflation-history.html

What Will $100 be Worth in N Years?

Source: http://observationsandnotes.blogspot.com/2013/01/what-will-100-be-worth-in-20xx-future.html

Summed Returns Over Time: Fort Collins

Using Fort Collins 2015 appreciation rate of 13.14% for each of the 40 years, the following is the chart of the summed returns. This is not realistic.

Yes, all the other returns are dwarfed by the return from appreciation. Here’s a chart showing the relative percentage of the returns with the same, unrealistic, assumption.

Monte Carlo: New Single Home Assumptions

IMPORTANT NOTE: The following is from my 100 Headed Hydra Spreadsheet.

Home Values from Monte Carlo

Rents from Monte Carlo

Total Return on Investment from Monte Carlo

The following includes Depreciation, Appreciation, Cash on Cash and Debt Paydown.

Total Return on Investment Summary from Monte Carlo

The Cost of Loss

The following is from “The Intelligent Investor” by Benjamin Graham.

Home Price Versus Rent

As you can see, while it does fluctuate year to year, the overall trend is that rent tends to track with home prices. And, we expect this, lest it become much better to rent or buy.

Assumptions for Nomad Modeling

In Scenario #2, Home Appreciation Rate and Rent Appreciation Rate are both equal to 0%.

Play with these assumptions in the Nomad Calculator Classic yourself using https://goo.gl/ELPRj2.

Debt Paydown

Debt Paydown doesn’t change on the first house, but since your purchase price on additional homes is the same, debt paydown remains the same for those as well.

Cash Flow

Since rents are not going up, cash flow is much worse and doesn’t improve until your mortgage is paid off.

But… with depreciation…

Depreciation

Depreciation is the same for each home since you’re buying all 10 homes for the same price.

Depreciation helps offset negative cash flow…

Cash Flow from Depreciation

Cash flow from tax benefits per house is $2,564 per year.

When combined with cash flow, it looks like this…

Total Cash Flow with Depreciation

Cash flow and depreciation is still positive $1,163 per year per house.

Total Cash Flow with Depreciation Over 4 Years

Your cash flow with property values and rents appreciating is much better when compared to no rent or house appreciation.

Total Cash Flow with Depreciation Over 40 Years

Cash flow with depreciation is consistent with no house or rent appreciation, except when depreciation benefit stops after 27.5 years.

It then improves once you’ve paid the mortgage off.

Total Cash Returns Over 10 Years

You still get debt paydown, cash flow (although negative in our model) and depreciation which is a net positive return of about $12K per year in year 2 and grows to $14K per year in year 10… on an initial investment of less than $15K.

Total Cash Returns Over 5 Years

Yes, it is much better with house and rent appreciation.

Amount Invested Each Year

Remember, we model Nomad to include down payment and negative cash flow even though negative cash flow is usually covered by depreciation (shown in previous slide).

This shows total down payments and negative cash flow.

The next slide removes the negative cash flow and shows just down payments since negative cash flow is countered by depreciation…

You end up investing less overall in down payments since home values are not going up.

Total Equity from Nomad

Equity is much greater if house values are going up.

If appreciation is really just inflation, this is really just “inflated dollars”.

You still end up with 10 homes worth what you paid for them, $286K, or about $2.86M in equity even with no house or rent appreciation.

Stock Market Versus Nomad

Traditional Nomad crushes the stock market—even with stock market at 10% per year.

No house or rent appreciation is much closer. The stock market overcomes Nomad—with no house or rent appreciation and stock market at 10% per year in about year 27.

We are counting negative cash flow against Nomad twice and not including depreciation benefit at all.

It is probably not realistic to think the stock market can do 10% per year with no inflation (appreciation).

Estimated Gross Minimum Income Required for Household

You’d need to earn more money per year from your job to qualify for loans to do Nomad with no house appreciation and no rent appreciation.

This is mostly from negative cash flow.

References

Improvement

The following are improvements I should consider making in the future.

  • Write out what I would say for each slide.

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