House prices historically appreciate in value, but that doesn’t mean you can predict when and how much prices will go up. In the last decade, the United States has seen a huge upturn in house prices, a huge down turn and another huge upturn. I own 14 rental properties and I fix and flip 10-20 houses a year so I am very concerned with housing prices. I like to make money when I buy a house, by buying below market value, but many investors live in an area with extremely high real estate prices and they invest hoping for appreciation. I understand why investors buy for appreciation, because it is very hard to find cash flowing rental properties or houses with enough room to flip in highly competitive markets. Investors justify their decision to invest for appreciation, because they feel they are in a great economic location that is highly desirable. I do not like to invest for appreciation, because there are so many factors that affect housing prices beyond our control. I love it when my houses appreciate, but I don’t need them to appreciate to make money.
Why do some housing markets appreciate more than others?
Real estate markets constantly increase and decrease in value, with some markets fluctuating much more than others. California has seen huge increases in real estate prices and huge decreases as well. Check out this graph of the historic home prices in Southern California from aboutinflation.com.
If you look at the chart, you see some ups and downs over the last 60 years in Southern California. This graph does not show the large increase in home values in the last year and a half, but prices have shot up again. Many investors feel California has many things going for it; great weather, good economy and an increasing population, which will continue to push prices up. But California had those same things going for it when the market crashed. The markets with the highest population growth and the best economies usually see the highest appreciation. However, the areas with the highest appreciation also see the largest decline in values when the market turns.
If you look at the above graph, you see a much more stable real estate market in Dallas. Companies like Toyota are relocating which is leading to more new home inventory. The prices in Dallas did not appreciate as much as California, but they also did not decrease as much as California either. Even with steadily rising prices for decades, Dallas saw a sharp decrease in prices during the housing crisis as well. If you buy and hold properties long enough in stable or decreasing markets, your home will most likely appreciate given enough time. When you are investing for appreciation without any cash flow coming in, how long can you hold properties until they pay off?
What are the risks of buying for appreciation?
The Dallas and California markets show the difference between highly volatile markets and stable markets. Most people who buy rental properties or flips for appreciation are doing it because they can’t buy for cash flow or a profit in their current market. They are seeing huge value increases and rents do not come close to making up for the prices they have to pay for properties. They hope the appreciation will continue and they will be able to sell for a profit in six months or a year. The problem is that prices do not always continue to rise even in very stable markets with a great economy and high buyer demand.
If you are trying to flip homes by counting on appreciation, you are running a very risky business. Many investors used this strategy before the housing crisis and they went bankrupt when the market turned. If you buy a fix and flip with enough profit to make money using current market prices you should be okay, even with a market down turn. If you buy rental properties hoping for appreciation and the market subsequently turns, you are stuck with a property that makes you no money and you cannot sell. Many investors did this before the housing crisis with rental properties and went bankrupt when the market turned. When you buy for appreciation, you have to have a lot of appreciation to make up for the cost of selling a house.
There is an easy way to avoid being that guy who loses all his rental properties to foreclosure; buy for cash flow and hope for appreciation.
Is it possible to predict what housing markets will appreciate and when?
Many investors look at every economic indicator they can to predict what markets will appreciate. Are there plenty of jobs, local colleges, emerging technologies, etc. They feel good economic indicators and a strong housing market will promote even higher housing prices. I do not believe this to be the case, because there are so many variables to consider with the housing market. Many investors went bankrupt in the last housing crisis betting on housing appreciation, because all the economic indicators looked strong. What factors will affect housing prices?
- Interest rates: If interest rates increase it could dramatically affect how much house people can afford and negatively affect housing prices.
- National economy: The national economy was a huge part of the last housing crisis; unemployment skyrocketed and people could not afford their houses anymore.
- World economy: It doesn’t seem like the economy of China should hurt the U.S. housing market, but it can. The China economy can affect the U.S. stock market and a decrease in the U.S. stock market could cause concern for the economy and affect the housing market.
- Building supplies: If building supplies continue to increase in cost, it will cause new construction prices to continue to increase as well. If there is a shortage of already built homes on the market, people turn to new construction. The cost of new homes can greatly affect the cost of already built homes. An oversupply of new homes can cause local housing markets to decline greatly.
- Lending guidelines: The housing crisis was caused in part by loose lending guidelines. People were able to finance over 100 percent of the value of their homes and when values stopped going up; they were underwater. Lending guidelines changed after the housing crisis making it harder to get a loan for a while. Now lending guidelines are loosening up again and we may see an increase in foreclosures.
- Foreclosures: The more foreclosures there are, the lower prices are because supply increases. I doubt we will see the huge price decreases we saw during the housing crisis, but a large increase in foreclosures could easily cause prices to stop appreciating and decrease. With loser lending guidelines there is a greater chance of more foreclosures in our future.
Given all the national and local factors that affect housing prices I think it is difficult for an individual investor to predict what housing prices will do. Prices could continue to rise or they could see a huge decrease as well if one of these variables changes.
Are you the only one betting on appreciation?
Investors will argue that their local economy is so strong that they can withstand the national variables that may cause prices to decrease. I do not agree with this argument either, because there are many other investors with the same idea. In highly competitive markets there are many investors looking to invest and they all may be justifying mediocre investments with the same reasons. Those investors are pushing prices up even higher than what the local economies and buyer demand can support. There may even be large hedge funds betting on that same appreciation pushing prices up higher. Just because a market has a great economy and high buyer demand, does not mean prices will always go up.
Can you predict housing prices in stagnant areas with no growth?
I think it is very hard to predict what housing markets will appreciate and when they will appreciate, but it is easier to see what housing markets will not appreciate. If an area has no growth or negative growth it will be almost impossible for housing prices to increase in value. Housing prices increase because there are too few houses for the amount of people looking to buy a home. If there are too many houses for the current population; housing prices will decrease and continue to decrease until the houses are removed or more buyers come to town. Many areas in the Midwest have very stable populations and they see almost no appreciation, because there is always an ample supply of homes for sale. Detroit has started removing houses to decrease the housing supply, because so many people have moved away. It may be possible to predict what housing markets won’t go up in value, but I am not sure what good that information is.
Housing prices constantly go up and down, and it is very hard for anyone to predict exactly when and how much they will appreciate. They may keep going up for one year, two years or more, but they may also start decreasing in a few months. The United States economy is going pretty well now, but that could change very quickly based on the climate, oil prices, the world economy and 1,000 other things I have no idea about. The great thing is you can still make a lot of money in real estate, relatively safely by buying below market value and buying for cash flow.