Dumb question about expensive markets

[Cori Leste]

I live in Oregon and looking for duplex within 90 minute drive from Portland. Everything on MLS runs waaayyy in the red for cash flow and and ROI. Example: new construction duplex listed for $469k. 3br/2ba one side and 2br/2ba the other side. BOTH units rented for $1300 each.

Serious question, who buys these? Buy and hold (like until forever)? Just curious how markets around me can be priced in a way that loses most investors money for years.

[Dan H.]

Price takes into account all sorts of things. This includes risk and expected return. The leverage compounds the return from appreciation. If I purchase at 80% LTV and experience 10% appreciation, I have a return of 50%. My belief is the smartest investors invest in the higher appreciation markets and the numbers back this up.

Case Shiller lists these markets as the three markets that have produced the best return for buy n hold this century (2000 to now): San Francisco, LA, San Diego.  I suspect every market at the top end of the list is a historically high appreciating market.

As for those that believe expecting appreciation for a well researched market is speculating, why is it any more speculation than expecting cash flow returns to not decrease?  If you think that is unlikely for cash flow to decrease, look at what happened to Detroit and Las Vegas during the Great Recession.  Last I looked Las Vegas was approaching pre-recession territory and Detroit had a ways to go.  These are two extreme examples but there are numerous less extreme examples.  Do you think rents declined in San Francisco, LA, or San Diego.  I know in San Diego there was no noticeable rent decline.  I know in San Diego in my life it has never not experienced appreciation over the long term; The GR took ~10 years for full recovery in San Diego and that is the longest stretch in at least 60 years.

I have purchased twice near top of market in San Diego.  In 1992, I purchased an RE for $167K.  It fell to ~$140K.  Today it is worth ~$630K.  In 2004, I purchased an RE for $741K.  It fell to about $620K.  Today it is worth ~$1M.  The point is that in historically appreciating markets, the people who lose money are not those that time the purchase poorly (but of course it is best to time it perfectly), but the people who are over extended and have to sell in the relatively short dips in the market.

As for cash flow, there is initial cash flow and actual cash flow. Actual cash flow is the cash flow experienced over the entire hold period of the buy n hold investment. My San Diego actual cash flow has been outstanding. We have one STR RE that has a rent to purchase ratio of 4%. Seems like good cash flow. The value has also increased 350% since purchase. The value increase results in rent increases. A market that appreciates will always eventually have better cash flow than the zero appreciating market regardless of initial cash flow of either market. It is a mathematical certainty.

It has been extremely difficult to have not made money investing in San Diego RE as my two poorly timed examples demonstrate.  Those purchases were both made near top of market and fell significantly in value.  They both look like fine purchases today.  That is the reality of investing in historically high appreciating markets; no matter how poorly you timed your purchase a decade later it looks like a fine investment.  This low risk, high returns are reflected in the prices.