There are two ways to make money in real estate–1) positive cash flow; and 2) appreciation (preferably leveraged appreciation). Ideally, you get both at the same time. Appreciation generally happens long term in every market as inflation raises the price of materials and construction. As new families are formed, there is demand for more real estate than exists so some will buy new construction. New construction prices will reflect inflation. Older construction values are brought up as well as they provide alternative housing choices to the new construction. They may require some repair and remodelling but are close alternatives to the new construction. So the old construction rises in value to be roughly close to the value of new construction minus the cost of repairs remodelling.
As the currency supply increases, the value of dollars go down relative to the values of hard assets such as real estate. If an investor pays cash for a property, the value of the property may go up with inflation but in inflation adjusted terms, the investor is not really ahead. That is where leverage is a big benefit. By using leverage, an investor can get ahead of inflation. If a 100,000 property goes up 10% in value to 110,000, and the investor only put down 10% (or 10,000 dollars), the investor has had a roughly 100% rate of return instead of a 10% rate of return. That leveraged increase will be more than inflation, 100% is more than 10%. This is a big advantage of buying real estate. But leverage cuts both ways. If a town is dying because the main industry is no longer viable (e.g., mining, autos, timber, oil), demand decreases as people move to other cities. If property values go down from 110,000 to 100,000, that’s a 100 percent loss on investment. Therefore, even if buying mostly for cash flow, it is important to try to buy in an area where appreciation is more likely.
Tech cities have traditionally outperformed non-tech cities. Think San Jose, Seattle, Austin, Boston, Raleigh, and Boise. The industrial rust belt cities have not performed as well except for those that have reinvented themselves. For example, Pittsburgh now has a strong life sciences sector. Recently, due to the Coronavirus, tech companies are letting their employees work remotely. This has given a boost to low density areas (e.g., South Dakota, Wyoming, Montana, Idaho) at the expense of high density areas (e.g. San Francisco, New York City). Whether or not companies start pulling people back into the office in their tech cities remains to be seen. It will probably happen to some extent as employees who work remotely are not as visible when it comes to handing out promotions or plum projects. Many employers have a tough time trusting employees to be productive without personal supervision.
Regardless of where you think appreciation will happen in the future, it is important to not assume that values always go up. There are 15 U.S. cities in which values have recently gone down:
Posh Irvine (Orange County), California has seen a price change of -0.26% in the last two years.
New Orleans, Louisiana has seen a price change of –0.22% in the last two years.
Peoria, Illinois has seen a price change of –0.19% in the last two years.
Edison, New Jersey has seen a price change of –0.62% in the last two years.
Stamford, Connecticut has seen a price change of -1.18% in the last two years.
Lake Charles, Louisiana has seen a price change of -1.74% in the last two years.
Santa Rosa, California, near many wildfires, has seen a price change of -4.82% in the last two years.
Laredo, Texas has seen a price change of -1.79% in the last two years.
Longview, Texas has seen a price change of -2.91% in the last two years.
Fremont, California has seen a price change of -4.79% in the last two years.
Redwood City, California, in the Bay Area, has seen a price change of -5.20% in the last two years.
San Mateo, California has seen a price change of -6.09% in the last two years.
Jackson, Mississippi has seen a price change of -9.95% in the last two years.
Some investors buy even when cap rates are low (as they are currently) and when there is no positive cash flow. They do so gambling on appreciation. Appreciation can never be guaranteed, as this list shows. It is a good idea to look for both appreciation and positive cash flow unless you have strong cash reserves to cover negative cash flow and have good reason to expect appreciation. If you have positive cash flow, you can wait out downturns in the market. Just don’t buy in a one horse town, because that one horse may die.
https://www.businessinsider.com/personal-finance/us-cities-where-real-estate-has-depreciated-2020-10