Most cities can be divided into cities that promote cash flow real estate investment or they are appreciation focused. In general, appreciation focused markets are not very affordable, are highly desirable and are more famous internationally. Meanwhile, cash flow markets tend to be more stable, less growth focused cities. There are investment strategies for each of these markets. This article is going to address investing in appreciation markets.
- Buy and Hold: If you have a long time horizon, have an appetite for risk and you have deep pockets, you can make a lot of money buying and holding in appreciation markets. The upside is that appreciation can average 8-10% in these cities, year over year. If you can find the hot sub market, you can get appreciation rates that are 20% you and higher. However, these markets rarely cash-flow. Investors will sometimes take that risk, hoping the appreciation will outpace their monthly outlays. If they are wrong, they might lose a lot of money.
Positives: High Profit, Simple Strategy
Downsides: High barrier to entry, could lose money monthly, might never make money back
- Develop: Appreciation markets are great areas to develop. The demand for housing is high, and new development will be worth a premium. However, appreciation markets typically have some restriction on new development. This is to say, if supply is limited and demand is high, there must be a reason that supply isn’t increasing. Typically, this is because these high demand cities aren’t interested in new development. New York, LA and San Francisco all have byzantine rules that developers have to follow, and active anti-development populations. Development is typically a high risk, high reward prospect and it is highly technical.
Positives: Lots of profit, sense of accomplishment for building a real thing
Downsides: lots of ways to not execute and lose all of your money. High legal risk as well.
- Value Add: This is a hybrid of the 2 above options. You buy properties with something wrong with them, and you fix them up. Then you either enjoy the cash flow from the higher rents, or you sell the property at a profit. This strategy has been the darling of the real estate industry for years, as it eliminates entitlement risk, allows some cash flow during construction, and is easier to execute. Unfortunately, after years of popularity, it can be hard to find deals today. Also, this strategy is probably the biggest cause of gentrification and societal change in a community.
Positives: Safer and quicker than development, while still creating value
Downsides: Hard to find assets, can cause issues in communities
- Repositioning: This is similar to value add, but it involves moving from one asset type to another. These can be some of the most fun and interesting projects. Examples are taking an abandoned industrial building and turning it into retail and apartments, buying a mall and turning it into an office park or taking a single tenant property and breaking it up into multiple tenant leases at a higher per foot price. The main risk here is you could read the market demand wrong. Is there demand for more trendy open concept office, or do people really need a food court?
Positives: Quick Profit, Interesting projects, less entitlement risk
Downsides: Highly technical, High execution risk.
There are a lot of nuances in each of these strategies, but this broad list covers nearly every type of real estate thesis. The next article will cover strategies that work best in Cash Flowing markets.