What does it take to force 25% appreciation?

Question

so instead of sleeping my mind has been wandering off..... One of its directions, and it could do worse, was real estate. The question stated in the subject is one of the areas my mind considered....in particular the question is in relation to purchasing a buy and hold property via hard money or private money with the intent of refinancing.....my train of thought, and it is likely wrong, is that sense most traditional mortgages require 20% down, it is in your best interest to rehab the property to at least 125% of the original purchase price. Thus an home you bought at $80k would need an arv of at least $100k. This brings me to the question within the subject line, on average, what would need to be done to force the home's appreciation up 25%? I assume more than just paint and carpet. Turning part of a garage into a master bedroom? Adding an enclosed deck? New siding?..... To narrow things down, as much as possiable without knowing market spacifics, assume your property is an $80k SFH that is 3bed1bath and around 1500sqft with a large yard and attached garage. What would you rehabers do to force the appreciation?..... (Sorry for the sets of [.....] But my Motorola G won't do paragraphs. Also hope I made this clear enough.)

Jesse T. · Answer

I think you need to go in at some discount to the current market price.  Really a 10% discount isn't unreasonable if the seller is paying agents or dealing with carrying costs.  The rest of the appreciation would have to be items that are keeping the house below the normal market value.

The trick is finding houses that have issues where you get compensated over the cost of repairs/upgrades for most of the upgrades.  The challenge is these are often accompanied with necessary repairs that are not compensated for in an increased purchase price.  You either need to get that difference reflected in a discount or pass on the property.

Chaz Reid · Answer

@Mike H.  I believe Bill Gulley is talking about getting out of the "typical mindset of investors" that just go looking for a discounted property. Instead of just looking for a good discount, look for a property that can possibly be changed from residential to commercial to where you don't have to try a forced appreciation, you just do paperwork to increase in the value of it. Seems like a smarter way of investing than the normal way of investing. I could be wrong about my interpretation as well though.

Bill Gulley · Answer

Mike H. my intent here is not to change the minds of self educated older landlords but to educate those willing to learn the foundations and principles of real estate that most have skipped over.

Those that don't care to learn usually don't understand the value of the theories the real estate industry is based upon, just as adding a 4th bedroom doesn't necessarily add value or putting 20K in and only increasing value by 20K.

You can lead a horse to water but you can't make him drink. Those that have already drank the Kool-Aid and may be making money have less motivation to change their thinking.

You're not just bucking basic real estate functions but business theories, accounting and acceptable valuation principles.

But, it makes a difference for new investors like the OP.

A real "discount" is a reduced price of an asset that has a history of selling at a higher price. You don't buy a parcel of real estate at a discount but at a distressed value due to defects and/or motivations of an owner. I'll mention too that those motivations need to be self imposed by an owner and not influenced by misinformation a buyer may introduce.

A property that is not exposed to an open market for a sufficient period of time doesn't meet the definition of market value, but is a distressed sale, if a buyer approaches and owner and they agree to a price, then that price IS the perceived value, need to consider the seller's opinion as much as the buyer's. Then, if an owner decides not to mess with a property and lets it go for less than they might actually think it is worth, that is a seller concession, it was worth it to them to sell at that price.

There is value to the efforts, the management and construction/rehab management that is required to bring a distressed property up to its highest possible value.

If you are to put 20K in a property and you can't realize the value of management, functionality and utility, it's not a good business decision or use of funds.

That means that what you add should not just be to pay for deferred maintenance and repairs to bring a property to a point where it should be, that's not much of an improvement.

You don't need degrees in accounting, finance, real estate or economics to understand the principles that RE business is anchored in, just the willingness to understand the concepts, adapt and adopt those principles to make more money which also includes saving money that can be wasted.

I've had more than 14 properties, but I find it humorous when old salty investors (operators really) base their success or theories of real estate on the number of deals they've done. Getting a property in you name and renting it out isn't really understanding the functions and principles of real estate.

Driving a truck across a pasture doesn't make an auto-cross champion, spending 20 years sailing a Sunfish doesn't make one an accomplished sailor.

Now, for those wanting to be accomplished champions, they will need to understand the techniques, principles and functions that are beyond elementary experiences, they need to kick up their knowledge to a different level.

Depends on where you're comfortable, but those they may want to learn shouldn't have to be exposed to dispelling comments of unqualified operators.......but that's part of public forums I know. :)

Bill Gulley · Answer

Really, investors need to get their head out of thinking of buying at a "discount" chances are you are not buying at any discount, you're paying close to what a property is worth at that point in time.....assuming you aren't talking to some granny without her being advised on a marketable property.....you can steal or cheat.

You're looking for the other side of that thinking, to the potential that may exist.

I've added more than 50% to properties without using a hammer or a paint brush.

Knowing what makes real estate valuable and why will guide you in identifying the potential of any property. You can't change the location, but you can change the use, the ability to transfer title and the potential income that can be derived from a property.

Rehabs are rather limited, you'll have a distressed value to buy, you add costs of materials, labor, carrying expenses, finance and settlement cost and you increase the value basically from the labor and entrepreneurship bring a property to its ARV. More often, you're at about 15 to 20%, some projects will yield more but contractors fees are similar.

Buying a farm that has been closed, paying 1,200 an acre and then changing zoning to commercial and multi-family use can triple, quadruple your price by doing the "paper work" and never do anything to the property.

Buying a house and changing it to a commercial office use can double your money without touching the property.

I got more than 50% by rewriting legal descriptions and doing a minor subdivision and never touched the dwellings or buildings.

External obsolescence are factors beyond the subject property that can effect its value, remove negative factors around your property and the value can go up, it becomes more desirable. If you have a neighbor running an illegal junk yard, you can expose the matter and get them into compliance, require them to clean the place out and your property becomes more desirable.

It's about seeing potential taking the value up rather than trying to talk granny down on her price for what a property might be at the time.

Reverse your thinking from the guru junk. You can either wait for time and the value of money to with inflationary aspects to increase value (which, BTW, your economic position may not be changing much) or you can force appreciation by identifying the potential of a property.

But, before you can start implementing strategies of forcing appreciation you need to learn the basics of real estate and the effects of market conditions. Much easier to learn than how to cut a mitered header straight, plum and set it level or building a cantilevered deck to code I'd think. :)

Larry Turowski · Answer

Mason V. is an expert at this, his goal being to refi enough so that he has recovered his all his starting funds with one year, and hopefully immediately.  But it is more about buying right than making the right upgrades.

You see, in my area, I need to put $20K into a property to increase its value $20K.   It is not so much that I appreciate the value of property over what I put into it, but that I got it at a discount to begin with because it was perhaps unlivable and un-mortgageable as-is.

Mike H. · Answer

That 70k was actually the purchase and rehab cost combined. I was trying to show a 30% discount (30k).

But that seems to completely disregard the actual ability to determine whether you're getting a deal or not. I just don't believe that a house is worth whatever I pay.

Based on that logic, it seems you're saying that if I purchase a house for 60k and put 10k in the rehab  and its worth 100k, that my rehab and management added 30k in value and I got no discount.

But what if I had paid 15k more for the same house? Does that mean that the same rehab and management was only worth 15k? No. Of course not.

If a house is actually worth whatever we pay, then you would either buy every house or no houses.

I guess what I'm trying to figure out with your "new fangled system" is what your criteria for buying a house would actually be. If the house is worth whatever you pay for it and you'll never get a discount, then how do YOU know when to buy a house - based on your philosophy?

And do you even care that the LTV will be 70% or better? My lender sure will.

So if you want to say I'm getting it for whatever its worth and my rehab is improving it to whatever the ARV is, thats alright by me I guess. But the fact is that I'm not forcing appreciation in terms of what this requester is asking for because the appraisal isn't actually going any higher than what the initial ARV was set to based on fixing the current property up to standards.

And here is how I determine if I'm getting the house at a discount or not. I don't really care what you call it to be honest. But my investing is driven by LTV percentage (so I can get the loans) and net cash flow (so that I can make money). Anything other than that, while possibly being an interesting theory, is nothing of real value to my investing beyond possibly a way to keep score (i.e. my rehab and management time added 40k this time, etc).

Bill Gulley · Answer

Edited:  Chaz, you are correct, thank you, well said.

Mike,

Simplified, when you bought at 70K that was the value, it was worth 70K. Then you rehabbed, added management, materials, labor and brought the property up to its potential value of 100K. You didn't get the steal of a deal buying at 70K, it was priced at about what it was worth and you saw the potential, added value and now you have more valuable property. You purchased a distressed property and cured the defects.

Terminology matters, everyone you speak to aren't going to be RE investors at a local club meeting. The thinking is, buy it lower than it's really worth, wrong, you bought at what it was worth, then you forced appreciation, you buy properties for their potential, not because of a dirt price. I've turned down free properties, basically they lacked potential with an economic value. Just because you think you're buying at a lower than whatever price, it there is no potential it's not a deal.

Look to the upside, not so much at the down side, there are more properties that have greater potential than those that are distressed in need of a gut or major rehab. :)

Mike H. · Answer

@Bill G. I guess I'm confused. Your post stated that investors can't buy properties at a discount.  And, to me, thats simply wrong.

But I do get a kick that you seem to be referring to me as old, salty, etc.

I've only been investing for about 7 or so years now.

What I can tell you is that when most normal investors talk about discounting, they're referring to the price below an appraisal amount and/or possibly what a house would actually sell for (sometimes an appraisal amount and an estimated sales price are two different numbers).

Either way, I still have no clue what you're talking about and I have no idea what it is you're trying to teach anybody.  I'm just making the simple observation that to suggest investors aren't able to get homes at a discount is silly and wrong.  At least in terms that most normal investors would understand the term "discount" when buying a property.

If my purchase and rehab costs are 70k and the house is going to be worth 100k, thats a 30% discount in most investors vocabulary. And I'm not sure why you would want to "teach us" that is incorrect.

Just because you say thats some new theory that everyone should start using just because you say so, doesn't mean anybody should.

Again, maybe I'm confused. But I'm just stating my opinion which happens to be different than yours that you can, in fact, find deals at significant discounts (i.e. 30%) without stealing from grandma. They're available in areas on the MLS even...... And I got these deals over the past 14 months so its not like I'm talking about 10 year old deals here.

Mike H. · Answer

I would have to strongly disagree with @Bill G. on this one. Buying at a discount is exactly what most investor are doing. Every single one of my 33 houses I own have been bought at a discount. In fact, they've been bought for at least 30% off what they were worth.

Well maybe I should clarify that and say they were bought for at least 30% off what they would appraise out at.  Ultimately, as a buy and hold investor thats all I care about. But everything I buy is with hard money and hard money lenders won't lend at anything above 70% LTV - at least not the ones that will lend 100% of the purchase and rehab that I need to use.

So, to me, that is where you get your forced appreciation - is when you buy it. Its very difficult to add value on rehab and actually get your money back.

Carpet and paint doesn't add that much more value. A 3/2, 1500 sq ft house with new carpet isn't going to appraise out better than a 3/2, 1,500 sq ft house with crappy carpet.  They might give you 5k for condition but thats about it.

At the end of the day, the adjustments they make are based on:1) Square footage.2) Bathrooms.3) Basement4) Garage5) Condition (although this is not used as often)6) Lot size

Strangely enough, I am not even seeing bumps for bedroom count. I have actually added bedrooms in some homes thinking that would add value. Appraisals on 3 of the houses I did had ZERO adjustments for the bedroom counts.  So whereas I had 4 bedrooms and the comp they used had 3, I got not bump for the added bedroom. They simply didn't care.

In reality, I get more rent for a 4 bedroom so I know the house is worth more to me. And I'm assuming its worth more if I were to actually try to sell it. But not so much in terms of an appraisal value.

So unless you are building an addition, adding a bathroom, finishing a basement, or building a garage, I'm not sure anything you really do adds that much value in terms of an appraisal bump.  You really need to get that discount on the purchase.

And if you can find the right areas, you can definitely get discounts of 20 to 30% off the market based on your all-in price.  i.e. House that will appraise for 150k when its rehabbed that your purchase price and rehab price total 105k or less.  They're out there. And in some areas, they're out there on MLS.  I'm positive because I've bought14 of em over the last 15 mos and have another 2 of them under contract as of last week.......

Matt Devincenzo · Answer

That is essentially what I've been doing to build my rental portfolio (buy-rehab-refi). I haven't pulled 100% of my costs out yet, but have gotten to about 90-95%. I know you're looking for a "list" of rehab items, but it doesn't really exist. By that I mean with SFR you need to shift the thought process from XXX(adding a deck, bathroom reno, extra SF) will increase the value by 110% of the cost...to the ARV of this home is $XXX and it needs $20K in rehab so my purchase needs to be $XXX.

The home's ARV will be set by the market, and you can figure that out by looking at comps. So using your 100K example, you know that is the max value you can obtain and by looking at those comps you know what the level of finishes in that property is that justify that value. Let's say that rehab cost is $20K, for simplicity sake.

Now you know that 100K is your target ARV and that you'll borrow on the refi at 80% LTV, meaning you need to be all in at 80K. So your purchase price has to be 60K or less. That is the real thought process that needs to go on.

It's different than the value add type of view you would take in a commercial situation. There you're looking at increasing NOI, with SFR you never "really" force appreciation because the value is set by the market as a whole. You're more looking at what you buying discount needs to be in order to end up with a comparable property for less than you put in.

Hope that makes sense, and helps as you're looking at everything.

What does it take to force 25% appreciation?

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