There are four ways to make money in real estate. Cash flow, taxes, mortgage principle paydown, and appreciation.
Three of these four are often misunderstood in how effective they are. Appreciation is one of those, and I’m focusing on that today.
Before I bash appreciation too much, here’s what the leverage lovers want me to explain first.
If you buy a house for $100,000 cash, and that house goes up by 4% in a year, the house is now worth $104,000 and you’ve made 4% on your money. Not amazing.
However, if you buy a house with $20,000 down on a $100,000 house and it goes up 4% in a year, it is now worth $104,000. You’ve made $4,000 on a $20,000 investment. You’ve made 20% on your $20,000 investment. The mortgage magnifies the benefits of the appreciation.
That’s a benefit of appreciation with a mortgage.
Of course, if you mortgage a property and it goes down in value, remember, you still owe that monthly amount to the bank no matter how low the price of the house goes. If the market crashes, you still got to pay that mortgage back at whatever price you originally borrowed for.
This was the big problem with the last real estate crash. It’s called being upside down on a mortgage.
Here is something I hear people say a lot about appreciation that makes me cringe.
It goes something like this:
“Well, I know I’m not making any cash flow on this house, maybe even losing some money, but that’s ok, because I’m in this for the appreciation.”
This attitude is especially common in high cost of living (HCOL) cities. Why?
It’s really hard to get good cash flow in a HCOL city. The price to rent ratios are way off. There is also this belief that these cities are great for appreciation, and you can’t go wrong buying because they will go up enough in value to make it worth it, even without the cash flow.
I’m here to tell you, this is not always the case.