While it may seem like yesterday to those that were impacted by the downturn, the mortgage collapse was already five year ago. While most people remember problems with adjustable rates and the massive amounts of foreclosures, there was another very important factor at play. Homeowners and investors made the assumption that their properties would continue to appreciate, even though they were rising at an alarming rate. They borrowed against their values until there was nothing left to squeeze out. Ultimately, when values dropped or tenants stopped paying, they were in trouble. Fast forward five years later and home values are starting to climb. There is the temptation to assume that values will only continue to go higher. If we learned anything from the mortgage meltdown, it is not to count on appreciation.
Adding short term value through repairs and upgrades should not be mistaken for long term appreciation. You can always add value if you buy in the right areas and do the right improvements. Long term appreciation is largely at the mercy of the market. In a typical year, a property will increase in value roughly 2% annually. At the height of the market last decade, values were rising 5-15% every year from 2005-2008. Even though those numbers were impossible to maintain, homeowners and investors saw no signs of the market slowing down. The rest, as you know, is history.
Many investors make the mistake of adding in 5-10% to their after repair value for appreciation and with the expectation that the market will be fully recovered in a few years. What if it is not? As much as the real estate market appears to be on solid footing, the current scenario does not mean it will explode overnight. There are many buyers who are still dealing with underemployment and are still not ready to buy. In spite of stricter mortgage guidelines, there has been no better time for buyers than over the past few years with low interest rates and rock bottom home prices. If buyers did not come out in droves with those advantages, what would make you think they will once rates and values increase? The market should continue to climb higher, but it will not happen overnight and there is really no guarantee it will happen at all.
Overestimating this amount will cause issues with every other phase of the deal. Instead of doing the work you wanted and doing it the right way, you will cut corners to save money. If your projections called for the home to sell for say $200,000 and the market is looking closer to $190,000, it will leave you looking to either take less or to rent the property and buy some time. You will still have options, but they will not be what you thought. Essentially, they could leave you scrambling to try and just break even.
Appreciation should not be expected, but viewed as an added bonus if it actually happens. If you are looking at the property as a long term hold, you shouldn’t get caught up with month to month or yearly value estimates. Check back in 15-30 years or as you get closer to paying the property off. Trying to guess where the market is can be exhausting and rather pointless. Keep your appreciation estimates realistic or you could be setting yourself for some problems down the road.
