Appreciation?

As the real estate market shifts in different areas investors must adapt to the changes in both their buying and selling strategies. Many people, including myself, strongly believe that you make your money when you buy a property at the right price. Recently, due to lack of inventory and/or more competition, investors have begun to buy outside my personal comfort level. I see them beginning to buy/invest based on future appreciation. If the appreciation comes the profits will be great but if not then they remodeled a house for a new owner for pennies or nothing.

Just two years ago I was acquiring single family residential properties for 65% LTV, last year I was still picking up a good amount of investments at 70% LTV and today I am having to go as high as 75% LTV. I understand that some areas are hot and demand is high but going above that seems ridiculous for a flip. Buying at a high LTV to rent I can understand but that is a whole other topic. There are investors who have given criteria that they will buy at 90% LTV. These are seasoned investors that buy, fix, and sell homes regularly. I ran into one of these investors the other day and had the opportunity to ask how he is making a profit buying at 90% LTV. He turned to me and said, “Appreciation!” As soon as he said this I already knew his business model. I myself benefited from the recent appreciation he was referring to on a few deals I joint ventured on this year. Essentially, he is figuring out the average appreciation in the area the property is located in and estimating what this property will be worth when it is renovated. He then runs his numbers based on those future appreciated values. Thus, while I am using current values and purchasing at 75% LTV he is buying based on estimated appreciated values at 75% LTV. This makes his true LTV greater than 75% based on current values and he would out bid my offer. When I benefited from appreciated values I still bought based on the current value. When I listed the property and ran a new CMA I adjusted the list price up to the new values. This increase in value was a bonus and nice to have but I did not base my entire investment on this appreciation. In fact, I could have still listed the property at the original ARV, undersold all the other listings on the market, had a better product, and sold even faster.

Hopefully, when you close on a property you buy it with plenty of equity while leaving room to remodel it and bring it back to market conditions. If your purchase price was not low enough, meaning you paid too much, you have already lost money. Assuming this is meant to be a home you want to buy, fix and sell you are now starting off with a low rehab budget. This can lead to a mediocre renovation which will cause the property to sit on the market for a longer period of time and possibly lead to price reductions that will leave very little profit. Now imagine if you were banging on appreciation to make a reasonable profit and the market cools down. You, the investor, now own a house that is worth more or less what you have invested into it. You have now spent weeks and/or months on a project that, after closing cost and real estate agent fees, may not turn a profit or at least not one worth the time. Therefore, make sure you do not buy with the expectation of appreciation. The great thing about real estate is that it is always a great investment because it is tough for it to become a liability unless you let it. You can always rent, owner finance, lease option, trade, etc. but why go to plan B if plan A can work just fine if executed properly.

As investors we all take risks when investing in real estate so there is no need to add another uncontrollable variable to the equation. Appreciation is a great thing to have when flipping a home but it should be more of a bonus when it does happen, not something to be depended on.