Appreciation Investors
Real Estate Investors can be classified in two major categories. The first is “Appreciation” investors and the second is “Cash Flow” investors.
An appreciation investor is one who looks to buy a property with little or no money down in areas of a city, county, state, or country where real estate is anticipated to increase in the next few years. These areas have large demands for property greater than the supply will accommodate forcing prices higher over time. The supply and demand imbalance is normally caused by population growth, job growth, or favorable, areas in demand because of their location, weather, and other desirable amenities.
For years, Las Vegas led the nation in population growth and real estate appreciation until the cycle was broken and real estate values plummeted forcing the last round of appreciation investors to sell at a loss. Appreciation investors try and locate properties with better than average rates of apperception (8% or more) and purchase in those areas with the intent of holding on the property for several years and then selling before the market peaks. It can be risking judging when that time really will be. Appreciation investors even buy properties that may not cash flow and even have losses each month if the appreciation rate is anticipated to be worth the risk.
For example, if an appreciation investor buys a home for $200,000 (10% downpayment, 6.5% interest rate, on a 30 year fixed mortgage) the monthly payment on the loan with property taxes and insurance would $1,138.00. If the market rent is $1,000 per month then the appreciation investor will be losing $138.00 each month ($1,656 per year) plus any maintenance expenses. However, if the property is appreciating at an average rate of 10% per year, the value of the home at the end of the first year would be $200,000 X 1.10% = $220,000. If the home sold in one year for $220,000, the profit the investor would make would be $20,000 - $1,656 = $18,344 in the first year. The cash on cash return is $18,344 (profit) ÷ $20,000 (10% downpayment) = or 92% ROI. This ROI is higher than can be expected because it doesn’t take into consideration property management fees, brokerage fees to market the property, or any maintenance cost. However, the return on investment is substantial even with these added costs.
The risks for the appreciation investors are 1) what if the property has reached its peak value and fails to appreciate as expected; 2) What if the investor loses income and cannot pay the month deficit payments; 3) What if expenses get out of hand and the monthly loss is greater than anticipated? If the market rent prices take a downturn the investor may not be able to make mortgage payments and lose the home like many did in certain parts of the country.
We don’t want to discourage anyone because most real estate investors buy their first two or three properties as appreciation investors to generate cash flow for the real estate business. This allows them to buy future properties with the equity they have accrued in those properties. Appreciation investing has a greater risk than
cash flow investing.
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