Appreciation or Cash Flow — Which is Better?
Yes I know, I am treading into a debate which in all likelihood would cause a real brawl if discussed over a few beers, but that is not my intention.
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My intention is really simple. Is today’s market a better market to be investing for appreciation or for cashflow? In some markets the answer might be BOTH, but I doubt it!
I am constantly discussing goals and objectives with new and experienced real estate investors and invariably the discussion turns to appreciation or cash-flow when it comes to income producing properties.
Now I realize that if you are an investor in California, one of your primary strategies before the housing market crash might have been to purchase a rental or two, not caring about positive cash-flow — all you had to do was own the property for a year or two, and its value would increase by an amount greater than your negative cash-flow. That might have been a great plan, but guess what? When the market turned downward, property values declined significantly and all you had was negative cash-flow, feeding the beast. Praying for appreciation didn’t seem like such a good deal. Did it?
Here is the number one rule every investor much live by every single day:
You Profit When You Buy!
I know this may not be new to you, but here is what I have learned this rule really means. When I mention that you must “profit when you buy”, what I mean is “You must purchase the property at a price that will ensure your profits based upon your ability to execute your exit strategy to extract that profit from the deal” and, in the case of rentals, you end every month with positive cash-flow and lots of it!
And guess what? If you are investing in hopes of appreciation, it is the only thing that you have any control of influence over. (Note: I realize that forced appreciation, possible in the commercial property world is very doable in any market, but this is not the appreciation I am referring to.)
In fact, investing today with appreciation as even a second or third objective is extremely risky!
Let me explain. In most markets today the housing market has not hit the bottom. Values have been bouncing around near the bottom and in a few markets there might be some appreciation, but it has not been consistent. To further complicate matters, most markets are expected to decline up to 5% throughout the remainder of the year.
If you were to invest with appreciation as any of your objectives the first question you have to ask is this. Where do I start my baseline? At the purchase price, which would be the most reasonable place to start or wait until my market has hit bottom and start there. Then suppose that this is your course of action. What could you expect future appreciation to be in the coming years? Assuming that you would realize some level of appreciation over 5 to 10 years, what amount of positive cash-flow would you require to make this investment worthwhile?
The reality is you can’t predict when the bottom will be hit or how much lower it will go nor can you predict what appreciation will be in the future nor as stated above can you control or influence it!
However, here is one thing that you can control and influence. In fact, you can, with reasonable accuracy develop and execute a business plan that will yield consistent cash-flow by just focusing on the cash-flow.
The bottom line is that appreciation may sound sexy, but remember you can’t control it! You can only control your cash-flow assuming of course you bought it right!