Do any of you purchase rentals purely for future appreciation?

[Jeremy Chaser]

My brother and I are both interested in purchasing rental property, and we have what appear to be very different ideas about what a good rental property purchase is. I'm curious what more seasoned investors think of these two methods for assessing rental property to make sure I'm not missing anything.

We are both looking in the same city with a lot of future growth potential. The city is currently investing mega dollars into the infrastructure to make it more desirable, and the market is very hot right now (consistent with most bigger cities currently). I think it would take an act of god for houses to not continue appreciating very solidly for the foreseeable future.

My brother only looks at houses that he would feel comfortable living in. We also admittedly come from a silver spoon background, which makes him ignore what I consider to be good rentals. The type of house he wants to buy is like this:

~200k

Located in a good neighborhood, desirable part of the city.

3 BR / 2 bath, solidly average middle-class home (no fancy counter tops, trim, etc.)

Rents of ~1,400/mo + util

I, on the other hand, tend to prefer something more like this:

~100-130k

Located in more blue-collar neighborhoods. Not crime-ridden or low class by any means, but certainly not a middle-class neighborhood.

3 BR / 2 bath. Very average homes, functional but not attractive kitchens, etc.

Rents of ~1,000-1,200/mo + util

My thought process is that these blue-collar neighborhoods, which also happen to be close to the downtown area where a lot of development is happening, have a lot of room to grow in the future. More importantly, they are priced close enough to the 1% mark that I can hold them for years and the monthly cash flow will be enough to pay for the house + a small positive income stream on top.

My brother, on the other hand, sees such tremendous growth out of the city that he thinks the houses have to be purchased in desirable neighborhoods to see massive growth out of them. My issue with his line of thinking is that if you pay 200k for a house that rents for ~$1,400/mo, you are holding a house for years on end that may just barely cover expenses, or even lose a small amount each month, in hopes for massive appreciation at the end.

Am I crazy for thinking that is a risky proposition when you can buy other homes that will earn you money each month while you wait for that hopeful massive house appreciation in 10 years?

[David Faulkner]

I invest primarily for appreciation, but with a few important caveats (to come later after the why) ... Why:

If you invest for cash flow and you are right, you get cash flow. If you invest for appreciation and you are right, you get BOTH appreciation AND cash flow because price increases and rent increases go hand in hand while most expenses do not scale up as such.

... and now, the caveats:

1. There are 2 "flavors" of appreciation: forced appreciation (which you control) and market appreciation (which you don't control but can screen for neighborhoods with high appreciation potential. I always want both ... the forced appreciation equity bump locks in some profits in the short term that you normally don't get from cash flow in these markets, and then the market appreciation does the rest of the heavy lifting for me over the long term (and if I'm wrong I still have my forced appreciation).
2. I live locally in a market that is perfectly geared for this strategy. I'm very much a product of my investing environment, but this strategy would not necessarily be optimal for all or even most other markets. In fact, I would even go so far as to say the advantages you'd have as an active local investor would likely trump any perceived or actual benefit you'd get in investing in one type of market or the other remotely ... so I'd say work with what your lcoal RE market has to offer, and that could actually be a fairly wide range with all the local sub-markets. 
3. Appreciation is impossible to accurately predict in the short run (1-8 years), but I believe that it is not necessarily all that difficult to predict in the long run (decades) if you have a market with a long established track record for it. In this case, you can estimate the long term historical appreciation rate by computing CAGR over multiple decades (spanning multiple RE cycles) and then understanding the driving fundamentals of supply and demand and if they are persistent or not. 
4. To some extent all buy and hold investors are relying on a certain level of appreciation, whether they realize it or admit it or not, and if they don't get it their investment could be in trouble long term. For example, if you assume 0% appreciation, because betting on appreciation is speculative, then you still have made an assumption about future appreciation that you could be wrong on and may either be conservative or extremely aggressive depending on the market you are in ... there are countless examples of mid-west rust belt markets where the appreciation has been less than zero after factoring in inflation, whereas an appreciation assumption of 4% in a market like SoCal has historically been quite conservative over just about any long term (decades) holding period. 

Of course, many would and have at length argued over any and all the points above, which is cool because that is how we all learn and grow, but these are my thoughts based on my experiences investing in RE for long awhile now (15 years).