What happens when a house depreciates? How do I prevent that?

Question

Hi guys, I am interested in buy and hold properties and was wondering what happens if a house depreciates. What are the factors that would cause a house to depreciate? On that note, what should I do when my house depreciates? This is because when the house depreciates, all my cash flow becomes pointless and I might lose money even. Thanks!

Jay Hinrichs · Answer

@John Warren  I bet John since he is from Ill is very versed on what causes real estate in a certain area to go down in value.

I will list a few.

social obsolescence

physical obsolescence

economic obsolescence.

factorys shut down towns lose jobs.

bad schools

crime

weather to an extent

and TAXATION  IE prop tax and income tax per state.

John W. · Answer

@Samuel S. @Jay Hinrichs is right, there are large areas in Buffalo where people took out a mortgage in the 80s/90s for more than I paid for the same house last year, and especially when you consider inflation, that is some terrible depreciation! Most of Buffalo has increased in price over last decade, but most of it hasn't returned to it's former glory, not even close. There are some gentrified areas in North Buffalo where houses are overpriced but a large part of Buffalo remains a sh*thole. In last couple years I bought a rented house on Newton St for $13k, a decent house on Oakmont for 10k, rented double on Paderewski for 12k,  single on Minnesota Ave for 25K, rented single on Forman for 17k, single on Beatrice for 35K....

Matthew Irish-Jones · Answer

@Samuel Chua and @Jay Hinrichs

For sure in Buffalo.  There used to be beautiful estates in Buffalo when it was a booming town.  When the cities economy collapsed in the late 70's early 80's everyone started moving out of the city and into the suburbs or out of the city completely and into other states.

City property was almost worthless for decades.  Conversely, more rural towns became much more in demand and real estate went up in the suburbs.

That trend seems to be reversion now as value is coming back into the city and a lot of millenials are starting to move into the city permanently and stay there.  2010 to current has been one of the best Real Estate runs in Buffalo in the last 50 years, probably the best run in reality.

There are still pockets and entire neighborhoods however that have not come back.  You can buy homes in Niagara Falls and certain parts of the city of Buffalo for dirt cheap.

Jay Hinrichs · Answer

this simply is not true at all.. at least about property being worth more in 20 years.. there are wide swaths of the US were housing prices peaked in the 80s and have never returned.  but I agree with you basically on Denver West and Premier locations of most cities..

but you look at say a Rochester or Buffalo or massive parts of Detroit.. houses cost more 20 years ago then they do now.

Samuel Chua · Answer

@Krishnan T.  I do not have much knowledge but I believe that house appreciation grows with the market. Meaning that if u are selling your property at 150k where it can be sold at 250k, u are actually depreciating the entire market unless the demand is very high. If the demand is very high in this case, property B will definitely appreciate slower than property A as property A can grow alot more before it hits its "market max" growth rate.

Lori Greene · Answer

Buy/hold/rent is usually a long-term strategy so you have to look at the big picture. There are always up and down spikes in every market with respect to market trends. But if you look at market values over time they almost always eventually go up along with everything else because of inflation. How much was a property worth twenty years ago compared to today? Almost always more.

With a rental, you should be more concerned with what rents are doing in the area rather than property value anyway. And rents also tend to move upward over time unless it's a bad area people are moving away from.

So shoot for areas with promise for job growth, new development, goods schools etc., by doing market research. And just let it ride on the properties you already own and do whatever you can to make your property better than the others with upgrades and superior property management. Over time, you'll most likely see your cash flow increase.

Andrew Kiel · Answer

I think we need to clarify "depreciation".

There's depreciation from a tax point of view, which is one of the benefits of real estate.   In the United States, the IRS says that you need to depreciate a (residential) property over 27.5 years - no need to go into detail here.

Then there is the possibility of actual depreciation based on the real value of a property going down (which I think is what you're referring to).  As a long-term cash flow investor, the underlying value of the asset is not my major concern, the cash flow and the spread (what I receive vs. what I pay) are.  If I buy a single family home for $200k and it makes $500 per month in cash flow and I plan on holding it long term - does it matter if it goes up to 225k or down to 175k if that cash flow stays the same?  Kind of like how Warren Buffet looks at the day to day fluctuations in the stock market.

There are certainly some things you can do to prevent the risk of depreciation. Buy good, solid properties in "B" class neighborhoods - does someone want to live in your property or are they just putting up with it because it's cheap?  You can also invest in many areas that don't have much depreciation risk, such as many areas of the US outside mainstream growth areas.  The downfall is you don't get much or any appreciation either.

John Warren · Answer

@Samuel Chua depreciation is actually a tax term. The IRS forces us to write off a portion of the value of our property every year over the course of 27.5 years. This is really a phantom tax loss, not a real event. In the U.S. depreciation is one of the main tax advantages of real estate as you can show a tax loss, but actually make money in real life! You should connect with a good CPA to learn more as the rules are obviously too complex for a forum post.

Bob Woelfel · Answer

@Samuel Chua Yes I believe Jay is right in that you were talking about the property going down in value?  I was not RE investing during the last downturn so take this with a grain of salt.  If you are talking about a property that you currently own then I'm not sure there is much you can do.  When properties or neighborhoods go down in value it's mainly because something happened with the overall market or there are things going on in your city or neighborhood that are negative.  More people are leaving it than moving towards it.  Perhaps the schools are getting worse.  Perhaps the neighborhood is changing and for some reason people are not taking care of their properties.  Perhaps it's become saturated with tenants/landlords and not homeowners.  There are a lot of factors and most are going to be out of your control if you already own this property.

Now, if you don't own anything yet then there are a number of things you can do to protect yourself and mitigate your risk.   Buy in markets that are desirable and where people are moving.  Buy in neighborhoods where this is happening as well.  Buy in good school districts.  Buy houses that are desirable in that you could eventually sell to a homeowner one day and not another landlord.

To your last point about losing money....this is an investment and you have to look at it that way.  There is always a chance with an investment that you lose money.  That's why due diligence is so important.  Best of luck.

Jay Hinrichs · Answer

@John Warren  John I suspect this OP is talking about what happens if a house goes down in market value.

not tax treatment for depreciation.

What happens when a house depreciates? How do I prevent that?

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