When should I consider home price appreciation when buying rental properties?

After speaking with thousands of investors over the years, there is one thing that has become abundantly clear: investors who are buying rental properties don’t know what to do with potential home price appreciation.  So, guess what happens?  They just don’t consider it.

It is much easier to focus only on the cash flow from rental income, so this becomes the sole decision-making criteria for many investors out there.  While this is certainly a simpler way to make a decision, it is also a strategy that can cost you hundreds of thousands of dollars over the life of your portfolio as you’ll see in my example later in this article.

“The goal of your rental property investment should NOT just be the highest cash flow.  Assuming the rental income covers the expenses, the goal should be the best risk-adjusted TOTAL RETURN ON INVESTMENT.”

The goal of your rental property investment should NOT just be the highest cash flow.  Assuming the rental income covers the expenses, the goal should be the best risk-adjusted TOTAL RETURN ON INVESTMENT.  Just looking at cash flows and judging success and failure can be deceiving.  Analyzing all profit centers including cash flow, tax savings, principal paydown and home price appreciation reveals the real winners and losers and ultimately determines when you accomplish your overall financial goals.

But what about 2008? Isn’t home price appreciation speculative?

You may be saying, “But Gregg, I watched what happened in 2008 when the real estate market crashed.  And now it’s hot again.  Isn’t it extremely speculative to count on any home price appreciation?”

My answer to you is it depends.  It depends your investment horizon.  If you are a rental property investor who plans to buy today and sell in the next few years, then there is no way you should factor appreciation into your investing decision.  Any home price appreciation gains at that point are speculative over the short run and they probably will get eaten up by your selling, holding and closing costs when you sell anyways.

However, if you plan to buy your assets and hold onto them for 10, 20 or 30 years or longer like I do, then there is data to support that home price appreciation is not speculative.  Home price appreciation performance is consistent if you give yourself that type of investment horizon.  And that’s why you’re hurting yourself if you don’t factor it into your decisions.

Historical home price appreciation rates repeat themselves over the long run

Real estate cycles tend to repeat themselves every 10-20 years in a specific city/region.  If you know the long-term historical appreciation rate and you plan to hold onto your assets for at least 10 years, then you can count on similar home price appreciation in your returns.  Take a look at the graph below which tracks median home sales prices in Jacksonville from 2001 to 2019.

According to the Federal Housing Finance Agency, Jacksonville’s average home price appreciation from 1991 – 2018 was 4.3%.  The red line on the graph is known as the “Projected Median Price” and it suggests what pricing would be if values continued to go up at 4.3% every year.  The blue line represents the actual median home sales prices.

Now we know that home values aren’t going to go up like that every year.  Sometimes the appreciation is higher, sometimes lower.  But values end up coming back to the historical norm for home price appreciation in a real estate market.

And that’s what you see here:  From 2001 to 2018, even during the greatest rise, crash and subsequent rise we’ll probably see in our lifetime, average home price appreciation in Jacksonville is almost exactly 4.3% on average.

This is a very powerful discovery that you should apply to your rental property investment decisions.  You SHOULD include home price appreciation into your investment decisions if you have a long-term buy-and-hold mindset.

The link between historical home price appreciation rates and population growth

There is also a strong correlation between the markets that have the highest historical home price appreciation and the markets where population in growing.  This should make a tremendous amount of sense as the more people moving to a location equals more demand for housing which leads to increased home price appreciation.  Take a look at the chart below.

Now, you may be saying, “Okay Gregg, I see the correlation.  But what does a 2.4% appreciation rate versus a 4.3% appreciation really mean in terms of my returns?”

Well, I’m glad you asked.  Let’s say you bought a $100,000 property in Cleveland in 1991 and you held onto it until 2018.  At an average of 2.4% home price appreciation over the last 27 years, your asset would be worth $188,000 in 2018.

Not too shabby!  The fact that real estate in Cleveland has appreciated 2.4% on average while population has decreased by 24% just illustrates that real estate is a hedge against inflation.  As the value of goods and services goes up around housing, housing tends to follow suit.

However, you might not be feeling so good about your investment decision in Cleveland when you consider what might have been if you had invested in Jacksonville.  That same $100,000 property purchased in Jacksonville in 1991 was worth $313,000 in 2018.

That’s an extra $125,000 worth of return you could’ve had if you had just paid attention to investing in a growth market!

Do we see now why we must look at potential home price appreciation when deciding between real estate markets?

What should my criteria be for choosing the right real estate market to invest in rental properties?

Now, before we all get excited about investing in growth markets, let’s put some guidelines around how to make the best risk-adjusted decision.  This DOES NOT mean that we should go all-in on investing in rental properties where home price appreciation is historically the highest.  You’ll wind up in California buying a million dollar rental property that burns a hole in your pocket every month when the rental income doesn’t cover the expenses.

The first rule of investing in rental properties is you must buy assets that pay for themselves every month.

But after you find a handful of markets that meet that criteria, you then must look at the following:

  • Must have over 1 million people
  • Look for highest population growth rates (over the past 20+ years)
  • Look for highest home price appreciation rates (over the past 20+ years)

I hope you see just how impactful home price appreciation can be as it pertains to your overall financial goals.  If you are a long term buy-and-hold investor, you are doing yourself a disservice if you don’t strongly consider potential home price appreciation when making investment decisions for your portfolio.  And, luckily enough, the metrics that are leading indicators are free of charge and can be accessed with a few clicks.  Do yourself and your financial goals a big favor and dig a little deeper to understand the home price appreciation potential before you buy your next rental property.

As a founding partner of JWB Real Estate Capital, Gregg Cohen has seen the company grow from humble beginnings to serving over 1,000 clients worldwide with total assets under management of over $350 million.  Cohen’s recipe for success in business includes a belief that whatever is measured gets improved and a true passion for creating passive income for clients.  Cohen and his team have been featured in The Wall Street Journal, The New York Times, Bloomberg, Inc. Magazine, The Jacksonville Business Journal and The Florida Times-Union multiple times.

Schedule Now

If you’re ready to get started with JWB, schedule a strategy session with our property investing experts now!