Hello to everyone, I have a question about projecting profits upon the rehabilitation of a home and rates of appreciation. I understand that one can estimate a projected profit in a rehab endeavor by subtracting the price paid for the property from the A.R.V. My second question is about using appreciation rates to calculate or estimate projected profits.
For example, the property I purchased will have an A.R.V. of $200,000. The rate of appreciation for properties in that area for one year is at 5%. This means that the property will gain about $10,000 in appreciation at the end of a one year period. I purchase the property for the price of $150,000. I sell the property in the exact time frame of one year. I have the following questions:
- Is the $10,000 in expected appreciated included in the profit projection estimate of $50,000?
- Should the $10,000 in expected appreciation be added to the projected profit estimate of $50,000 making the projected profit estimates around the amount of $60,000?
Thanks to all that review and reply to this post.
If you need to rely on appreciation to make a rehab opportunity profitible than it’s not a good deal to begin with. Appreciation is a wild card when it comes to real estate and no matter what anyone tells you, NO ONE can predict it. There are so many factors that go into factoring the appreciation for a given area that you’ll fry your mind. Right now most of the country is a little past the high point of this real estate cycle and inventory is rising substantially. While we’re still experiencing rising property values, this will be the next thing to fall once the inventory level of houses on the market exceeds 10-12 months worth.
If you need to factor in appreciation to realize a profit from a rehab/flip property, then you’re not buying low enough.
Thanks for the information and response Visual_Underworld. Your feedback is appreciated. Also, I am concerned with the topic of appreciation because I am currently studying the mechanics of lease-options. Some of the literature that I have read on lease-options factor in future appreciation on a property to calculate profits and establish the purchase price of the property. As it relates to real estate investing, when is appreciation a major issue for the investor? Or does appreciation only a major concern when offering lease options?
Usually, but not always, the lease-option contains the agreed upon purchase price directly in it. Let’s say that the property is worth $100,000 now and you’re in an area expecting to realize an estimated 7% average appreciation for the life of the lease-option, say 3 years in this case. A fair selling price would then be the price after 3 years, which in this case would be $122,500. You can also say in the lease something along the lines of “if option is exercised, said property will be sold to tenant at FMV (Fair Market Value)”.
The latter may be the way to go if you personally think that the house value will exceed the estimated appreciation rate. However, no one can predict the future and if appreciation flatlines or goes negative for a bit you may have stood to gain more by having agreed upon a price. Not to mention you’ll likely have to pay to have an appraisal done to obtain the FMV.
Also, remember that your goal is to actually SELL the property to the tenant, not to “foreclose” on it. If the tenant believes that they are getting a decent deal they’ll take care of the property as it were their own. If they realize at some point in time that they are being ripped off, they’ll trash the place. Charge a small premium for the lease-option, but don’t drag them over the coals. This is in the owners and tenants best interests.
Thank you for the information Visual_Underworld. What percentage of the current market value of the house should the investor charge for the lease option premimum?