How much Appreciation do I Account for?

Question

If I buy a SFR in Denver how much appreciation should I account for when calculating IRR?

I know each area of the country appreciates differently. Do you use the national inflation rate? Is there a website or tool you use?

Thanks in advance!

Llewelyn A. · Answer

@Scott L.

2 points here.

1) There is NO SUCH THING as a cash flowing property.

Imagine that you and I are going bid on 100 Main Street for $100k.

We are going to finance it differently. YOU will buy it with a NO MONEY down 100% financed Mortgage and I will buy it with All Cash.

If you buy 100 Main Street with a $100k Mortgage, you will be at a negative cash flow because of the Mortgage.

If I buy 100 Main Street with no Mortgage and 100% cash, I cash flow like crazy.

So, what is 100 Main Street? A cash flow property or not?

IT IS NOT THE PROPERTY that Cash flows, it is the INVESTOR that Cash Flows the Property.

I still don't understand how so many investors don't understand this rule. This is just the Math and the Math will tell you the truth.

2) I have been buying Brooklyn, NY properties for 21 years. If I assumed ZERO appreciation 21 years ago, I would not have made over $10 Million in Appreciation for my Partners and I.

Imagine buying a 2 family in the year 2000 for only $140k using a $119k Mortgage and $8k closing costs. My invested capital was $21k down and $8k closing and $40k in renovations = $69k invested.

I can sell that property today for $1.1 Million, commission of say, 2.5% which would be $27,500 (I'm a Broker so I only pay the Buyer Broker's commission), remaining mortgage balance of say $70k and some closing costs of about $30k. I will walk away with $972,500 in my pocket.

That's a profit of $972,500 minus $69k invested = $903,500 profit. The ROI = $903,500 / $69k = 1,310%

Note, this does not even include the Cash Flow which over time, became very large even though I started with virtually zero cash flow.

I also do IRR Spreadsheets over a 10 year projection. You have to assume some conservative level of appreciation otherwise you can miss these kinds of gold mines.

What was tragic is my friends and family, most of whom did not buy any Real Estate in NYC. They and their children are forever priced out of the Market. Buying where there is large appreciation is a must if that's where you want to live or you take the risk of being priced out. Most of them had moved to lower priced Cities because they just couldn't afford to live in NYC anymore.

I also had another friend that bought for cash flow out of State. He made the unfortunate choice of loving NYC and stayed as a renter in Manhattan.

In 2004, we both bought Investment properties, but I bought in Brooklyn, he bought in CT and cashed flowed about $1k per month. My 2004 property did not cash flow much at that time.

Today, my friend's property still cash flows $1k per month and his property barely went up in the 16 years he owned it. Unfortunately for him, his Manhattan rent went up more than $2k more per month... making his net a NEGATIVE $1k cash flow even though he is positive cash flowing in CT.

Contrasting my 2004 property, I received about $2 million in appreciation and cash flow over $5k per month more than the zero cash flow I started out with.

These are real scenarios that has happened. It's incredibly tragic when 90% of your friends and family are forever priced out because they completely missed the boat.

Luckily, my Brother was one of the 10% of my friends and family that bought just 1 property in Brooklyn in 1994. That property was appreciated more than $1.5 Million.

My Brother's kid is a pretty smart kid and got accepted to an IVY League school but the tuition was $50k a year. Well... that's no problem. My brother just taps into that $1.5 Million of equity and the kid graduated debt free instead of owing the $200k it cost in tuition.

What's even better is that the appreciation in rents paid for the equity loan and he still makes a lot more in cash flow.

Anyway, I am not going to beat a dead horse again. You get the point.

Since you are doing an IRR, you can compare both properties that you can cash flow but will have ZERO appreciation (places like Reading, PA etc) and places that you may have little cash flow initially but will have some or a lot of appreciation.

When you do your IRR, all you do is pick the investment with the better IRR. I have yet to see a property where I assumed zero appreciation beat any IRR I have modeled in an Appreciating market.

HOWEVER, these days, I reduced my appreciation assumptions. Instead of using a conservative 6% to 8% in NYC, I'm only using 4% per year. That has put me in a holding pattern and has made me look elsewhere, potentially out of state.

One last thing, a lot of people would say you can't predict the future. But if a squirrel does not store his nuts before the winter, he will starve to death. If a squirrel can predict the future, why can't we?

Account Closed · Answer

I never consider appreciation in buying a property. Sure, it may go up in value over time, but if it doesn't cash flow today, I'll pass. Here is how to look at it for the best returns: And I don't understand why someone from CA would buy in Ohio where the laws, economics and returns are so depressed compared to the option of NV and AZ. But, to each his own.

Average Turnkey Cash Flow Per Door In Phoenix
Metro Area No Bank Financing Needed

https://www.biggerpockets.com/forums/600/topics/584916-average-cash-flow-per-door-in-phoenix-metro-area

James Carlson · Answer

@Scott L.

To be the second contrarian, this "don't bank on appreciation" rule is just wrong for certain markets. (Markets like Denver, for instance.) This is not to say you should buy cash-flow negative properties, but like @Chris Lopez pointed out, there are historic appreciation numbers that you can pull to see how a certain city does. On top of that, there are markers you can look for in a city to gauge it's potential for growth. Net migration, high-paying jobs/companies coming in, low unemployment, etc. To not at least consider appreciation would be like not considering the future appreciation potential of a stock.

Now, maybe your market doesn't historically appreciate well, and so then you bank on zero to little appreciation, but that's not a rule that applies to all markets.

When we buy, we're getting places that cash-flow, but we are also certainly considering the long-term appreciation potential. But we're also keeping everything we can. It's a long-term play. It's worth noting that if you think you might need to sell in 2-5 years or so, no one knows what will happen in the market.

Chris Lopez · Answer

@Scott L. I don't agree with most of the posters. If you're running an IRR calculation, you need to assume some appreciation rate. You may want to run various scenarios of appreciation or no appreciation.

In all of Denver metro homes have appreciated an average of ~6% a year for the last 45 years (1974-2018 - the data is pulled REColorado).

In Denver, home prices have gone up in price all but 4 years in the past 44. So, just because we're at record high prices doesn't mean prices will fall the next year. Most years we are at record high prices.

Personally, I use a 3% appreciation to model my IRR calculations. Many of the investors I know use between 3% to 5% for their modeling purposes.

I don't buy negative cash flowing properties, the numbers work and they are safe, but I expect appreciation in the long run. Look at the job growth, population growth and super low inventory... there's a really good chance for appreciation.

Don't plan on just appreciation, but it sure can build a lot of damn wealth!

Craig Curelop · Answer

@Scott L. - If you are buying an investment property, appreciation should be the last thing you think about. Especially if you are on your first few. I recommend buying cash flowing properties in the greater Denver area and let the appreciation take care of itself.

In a situation where you are stuck between two properties and the numbers are roughly the same. That's when I would factor in the appreciation piece.

Areas that I believe are poised for highest appreciation are: Villa Park, Barnum, Athamar Park, Edgewater. If you go outside of Denver, I like the Arvada, Westminster, and Thornton areas. Though... some areas within the suburbs are better than others.

Steve K. · Answer

Depends on where in Denver. Some neighborhoods in Denver metro went up 20% last year, others went down 4%. Real estate is hyperlocal that way, and there are many, many sub-markets within Denver that are likely to perform much differently from each other moving forward as they have in the past, so it depends on exactly where in Denver. It also depends on your hold period; next year might not be great but over ten years the average is likely to be much greater than 3%/inflation most places in Denver IMO.

Tyler Howell · Answer

@Scott L. In the current Denver market, there are 2 ways to cash flow (significantly): large down payment or find a screaming deal. Distressed properties are hard to come by, and properties sell at price points that don't typically allow much cash flow. Don't get me wrong, there are likely people on this thread with the inside edge to snag cash flow properties, but these likely aren't Midwest-caliber cash flow figures. @Thomas Cummings is correct, cash flow is great if you can find it, but appreciation is more powerful and is the main driver behind demand for SFR and small MFH rental investments in Denver.

Thomas Cummings · Answer

You can’t plan for it.  Nor is it guaranteed. But appreciation is sooo much more important than cash flow.  Few hundred dollars a month gets you $3-4K In gain. 3% appreciation on a $300k property gets you $9k.  If you put down 20%, or $60k, now your at a 15% return.

Kenneth Garrett · Answer

@Scott L.

I never count on appreciation since it is unpredictable.  The economy turns then the appreciation is gone.  You should count on cash flow and the advantages of depreciation, mortgage buydown, interest deductions, and property tax deduction.  Any appreciation is a bonus.

Ryan Evans · Answer

None. Appreciation is great but you shouldn’t count on it. Especially at the top of a market. It can make the numbers look good but try to find deals that can work without factoring in appreciation.

How much Appreciation do I Account for?

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