Seeking High Volatility Markets, Which would you Choose?

Question

I have something of a theoretical question. My current strategy has been to invest for cashflow, and to these aims I have purchased a triplex in my hometown of Spokane and am under contract for my first SFH in Indianapolis. I expect to continue purchasing SFR in Indianapolis, but this weekend was considering the tangent of investing for appreciation.

Let's assume that investing for appreciation is pure gambling, but the good news is that the dice are rigged. If I get appreciation on a property, I can 1031 it into a cash-flowing property later on, without having to pay taxes. If I lose the appreciation game, I can sell the property and deduct it against my regular W2 income, meaning that I get ~55% of the money back (highest tax bracket, live in CA). Not bad right?

The caveat is that this sort of gamble makes more sense in higher volatility markets. If the appreciation is low, (i.e. only 3%), transaction costs are going to eat all of my gains. However if appreciation is highly stochastic (even if the mean is zero!) I can gain significantly from the tax implications.

With that in mind, what would be good markets to roll the dice? Primary criteria is high volatility in real estate home values, with a secondary criteria of low cost of owning property. (As measured by cashflow)

Quick scans of Zillow reveal the following candidates:

(Note that I treat zillow predictions as a measure of expected variance, not a measurement of expected growth!)

Tacoma: 13.4% appreciation last year, predicted 6.0% appreciation this year

Portland: 20.1% last year, 7.5% predicted this year

Dallas: 17% last year, 7.6% predicted this year

If you had rigged dice, which market would you roll the dice in?

Account Closed · Answer

Portland is not "highly volatile."  "Highly volatile" would suggest roughly equivalent depreciation during economic downturns.  Portland did experience depreciation during the last recession, but only about 20%, which is low compared to many other markets.  While Portland is likely a growing market, at least for a little while, you've probably already missed the boat (2013-2016) and would be buying high at this point.  Prices started to soften this summer.

If you're looking for "highly volatile," I suggest to look into locations that experienced drastic devaluations in 2008-2011, e.g. Las Vegas, Phoenix, Miami (but get out before rising sea levels obliterate it), etc.  Probably also a good idea to avoid over-leveraging.  Then time the market. Good luck!!!

Luke Mccandless · Answer

@Jonathan McKay I live in the bay and am also from Spokane ! Per your question, I am a big fan of Portland, and lived and owned property there.  As more people start to see the Bay Area as just unlivable due to cost of living, Seattle and Portland are fantastic alternatives, they are going to be strong markets imo for a long time. I 100% agree with Account Closed though not as "volatile" which may not be a bad thing.

David Faulkner · Answer

Yes, you can force appreciate in any market, and it will be the same amount of work, the difference is that there will be an extra zero on the end of the profits on forced appreciation in a high demand market.

1: Real estate as it is practiced here is an active investment. In an active investment, boots on the ground are critical and you want concentration where you have a strategic advantage, which is usually your backyard ... if you want to diversify, then buy a passive investment like a REIT or S&P500 index fund and be done with it.

2: 6-8% has been the long run average appreciation rate over the last 40+ years, and for almost that entire time it has looked expensive compared to other markets if going on price alone and people have been saying it won't keep going ... ask some old timers and look at the historic data if you don't believe me ... if you are talking about just this cycle, you may be right, but if you are talking long term, which is where your head should be IMO if you are getting into buy and hold REI, then I think the underlying supply and demand fundamentals are solid.

Jon Nelson · Answer

if your looking for appritiation I always look for something that seems to be out of wack. I am currently buying in the Chicago area in Indiana where the houses coast the same as Illinois and the rent is the same but taxes on a $100,000 house are up to $4000 less which investors are not paying attention to but when home owners start buying they will pay more in a area with lower taxes.

I also just went to Fort Lauderdale and you can buy a condo for $50,000 that rents for $950 I bought 3 of these in California 5 years ago and they are all worth over $120,000 so for me it's not just the area but looking for something out of wack in a area.

Jonathan McKay · Answer

Account Closed- I would love to find some leading indicators that I could correlate with future appreciation, but I'm not nearly that sophisticated yet.

Edward Rhoads · Answer

Ok.  If you are not looking at cash flow then you are wanting to fix and flip and do it as quick as you can so appreciation will not be an issue.  It will be if you can find a property for 70% of ARV.

Sadly that is tougher to do in areas that are hot as there tend to be speculators who count on the appreciation.

Edward Rhoads · Answer

Here is the thing to consider....

Appreciation is not enough.

What will you be doing with these houses?  if you are doing fix and flips appreciation is worthless for the most part.  Might get you a few percent but it is not what you are wanting to count on.

Appreciation is only good for rentals that you want to hold onto for 5-10 years.

However, then you have to consider rents.  In most of those cities the ratio of rent to property value is not great.  In cities where the rents are great (like my Indianapolis) the appreciation is low.

So, what you want really depends on your end game.

Jonathan McKay · Answer

Obviously, I would pick a market where the expected appreciation is as high as possible. Forcing appreciation is also a good strategy, but one can do that regardless of market. From what you are saying, it sounds like you would advocate buy and hold in high appreciation markets?

SF is a market to consider, but I'm hesitant for two reasons.

1: Highly correlated with current income.

2: I don't think there's 6-8% long run appreciation left in the market for SF.

David Faulkner · Answer

Why not "roll the dice" on a market with highly stochastic appreciation where the mean is NOT zero (but more like 6%-8%), then further tilt the odds in your favor by forcing some appreciation and still getting your long term cash flow from rent increases while not worrying about having to try to dance in and out of investments at the perfect timing via 1031 exchange and eating transaction costs? If you are going to invest for appreciation, that's a much better business model IMO, and as an added bonus, you have only to look in your own backyard to find a suitable market for this strategy ...

Seeking High Volatility Markets, Which would you Choose?

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