Investing in rental properties can be a lucrative way to make money in real estate and attain financial freedom. You can reap investment returns in a number of ways including cash flow, appreciation, tax benefits, and equity built through mortgage payoff. However, there are essentially two main profit centers that should drive your decision on what rental property to purchase: cash flow vs real estate appreciation. Not all rental properties offer both of these or in equal proportion. Therefore, when you set out to acquire a rental property, the first thing you should do is to determine your strategy (depending on your goals). How do you want to make money with the rental property?
There’s a spectrum for investing for real estate appreciation or cash flow. You can invest solely for real estate appreciation, for cash flow only, or for both. In this blog, we are going to focus on real estate appreciation and answer the question “Is it a bad idea to invest solely for real estate appreciation?”
What Is Real Estate Appreciation?
Real estate appreciation is the increase in the value of a property over time. With this strategy, investors look for properties that they believe will increase in value over time in the hope of selling it later at a profit. That way, they will enjoy a positive return on investment when they sell.
There are some key factors that influence real estate appreciation which you should keep in mind as you shop around for real estate. They include:
1. The Location of the Property
The first key step to achieving a good return on investment with the buy and hold real estate investment strategy is choosing the right real estate market. Average real estate appreciation rates vary considerably by location. For you to have a good return on investment, your property must be located in an up and coming real estate market. You need to conduct thorough market research before you commit to a particular real estate market.
Fortunately, there are some factors that you can use to identify growing markets. Together, these factors will ensure that your property grows in value. Hence, they can signal a good real estate market for real estate appreciation. Here are some of the key factors to consider:
- Growing job market and general economic growth
- Availability of desired social amenities like schools, hospitals, restaurants, etc.
- Future development plans e.g. construction of shopping malls, etc.
- A growing population
- High absorption rate
- Shrinking vacancy rates
When looking for top markets for real estate appreciation, you should also look at the historical real estate appreciation figures. You want to invest in markets that have a consistent annual appreciation and not just sudden boosts in appreciation. Therefore, it’s important that you consider the factors that are driving this appreciation in value. There are several factors that can trigger real restate appreciation but not all will lead to long term real estate appreciation.
2. The Time You Buy
You should also keep an eye on the real estate cycle and match it with your investment strategy. If you can determine the current real estate phase, you can make an educated real estate appreciation forecast. For instance, if you buy in the middle of a housing market crash, you are more likely to experience massive real estate appreciation. At this point, property prices are lower than usual and most likely will go up.
3. Cost of Borrowing
Another factor that influences real estate appreciation is the cost of borrowing. When mortgage interest rates are low and the lending guidelines are loosening, more people will be able to afford the cheaper mortgages. This will increase the demand for residential houses and cause them to appreciate in value.
4. Property Characteristics
Apart from location, investors should also consider the actual investment property. For instance, if you buy a slightly distressed property at a discounted price, you can force appreciation by making some improvements. Moreover, the appreciation rate for different property types will vary depending on the neighborhood.
Should You Invest Solely for Real Estate Appreciation?
If you invest solely for real estate appreciation, you will be depending 100% on your investment property to appreciate to make money. That’s what makes it a very risky investment strategy.
While it’s possible to predict real estate appreciation, there’s never an absolute guarantee that property value will increase. Even experts can’t predict it accurately. In essence, investing for real estate appreciation is a bit of a gamble. You can be lucky and make some good money but you can also incur huge losses if the property doesn’t appreciate as expected.
As a beginner real estate investor, you shouldn’t bank on real estate appreciation alone. It’s a very risky investment strategy. No matter the amount of research you do, you can still end up selling at a loss, all the while losing money each month before the sale. Regardless of your goals, it’s recommended that you invest in positive cash flow income properties with some chance of appreciation.
Positive cash flow means that the property will be putting money in your pocket every month. Cash flow properties can provide you with steady passive income and allow you to purchase other investment properties. Of all the real estate investment strategies, cash flow investing is arguably the most predictable and straightforward. With the right tools, you can get a reasonable estimate of potential cash flow and reduce investment risk.
If you are thinking of investing in real estate in the US, be sure to use Mashvisor’s investment property calculator to quickly and accurately estimate cash flow and return on investment metrics.
Investing solely for real estate appreciation may only make sense if you are a high-income earner and have a lot of money in reserves or when it’s only a small part of your portfolio and you have good cash flow from your other income properties. This way, you will have a cushion against losses in case things don’t go as expected.
The Bottom Line
Investing primarily for real estate appreciation can create opportunities for substantial one-time returns but is also a high-risk venture since appreciation isn’t guaranteed. It can lead to wasted money and time. Smart real estate investors should target positive cash flow first and then aim for real estate appreciation over time. Either way, be sure to do thorough research before making a move.