Real Estate Investing Basics

Appreciation or Cash Flow — Which is Better?

89 Articles Written

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!

Peter is an active and successful real estate investor in the Baltimore Maryland region for the past 8 years and is one of the founders of The Club Mastermind a real estate investing coaching program focused on local coaches helping investors to perfect their game.

    Replied almost 8 years ago
    I 100% agree. You can control cashflow, but not appreciation, and you must buy with a profit. You won’t go bankrupt or get foreclosed on if you continuously have more income than expense. Invest for cashflow, appreciation can be an added bonus. Here’s 5 of my investing rules:
    Replied almost 8 years ago
    Peter, I really agree with your post, especially since I am a CA buy and hold investor. My strategy is similar to what you’ve outlined above, but with a slight twist. I only buy in markets where the purchase price is well below the cost of replacement and where I can still actualize monthly cash flow. My thinking is that the cash flow will stabilize the asset for as long as I need it to. Down the road (maybe WAY down the road) when the excessive REO/short sales have worked their way through the system the prices should revert back to the cost of building. This, in my opinion, isn’t really appreciation, but it does provide a nice built-in profit. Thanks for the high quality post. Arthur
    Kyle Hipp
    Replied almost 8 years ago
    Great article. I have focused on duplexes for long term rental income. I also try to control the “appreciation factor” somewhat by purchasing a home than needs repair or I can develope a great idea to improve the portperty. With total costs my cashflow is aweful because I am putting money into the property. By purchasing this type of property at a discount I can recoup all my costs of repair and remodel with equity in the property. I also improve the rentability of the property which allows me to raise rents and improve my cashflow. One thing that has helped lately is picking up properties on land contract where instead of using cash for a down payment I can pit it towards repairs and remodels. Then with a great property I can refinance to my pleasing, sometimes with even the option of doing a cashout to some degree. Its so vital to look at the big picture. Anybody can do great when times are good but setting yourself up for success when things go wrong takes it to a whole new level. Great post!!!
    Phil Boren
    Replied almost 8 years ago
    Peter – You make some excellent points here. I do think that the answer, like most real-estate answers is, it depends. Here in Boulder, CO, for example, many investors buy with the expectation of a lower return and banking on future appreciation. In fact, many local investors will accept a break-even scenario. By contrast, I know in other markets investors are more demanding about annual cash flows and don’t have lofty expectations about future appreciation.
    Ronald Cagape
    Replied almost 8 years ago
    Great post, Peter. In the Philippines, many investors are still married to appreciation especially since the market is growing. It is challenging in this environment to find properties that are way below market that have positive cashflow unless you fork out a significant downpayment. Challenging but not impossible. I do agree though about investing for cashflow. It’s the only thing you can count on.
    Bill Lyons
    Replied almost 8 years ago
    Cash flow, cash flow, cash flow
    Frank Rizzo
    Replied almost 8 years ago
    There is risk and reward with any strategy, but even in today’s market you can bank on appreciation if you bought right. The key is targeting properties that are under today’s value and project under the current trends. For example, if I am looking at a flip project right now in my market, I take in to account that by the time I able to put the property back on the market, I maybe 3% lower that the current comps. If my purchase price, development and soft costs still leave me margins that I am comfortable with, even with a discount to current market, than I will get involved. Otherwise, I am readjusting my purchase price. Remember, there are no bad properties, only bad prices. Even when you are investing for cash flow, always analyze your equity position every year. It’s not the cash flow that I look at, but the rate of return on the equity that is in the building. If that ratio is off, it’s time to move on to a higher yielding investment.
    Tom Blue
    Replied almost 7 years ago
    Peter: I have heard that cash flow is better to focus on from many investors, but look at the billionaires list. They all made their money on appreciation…