Cash Flow or Capital Gains?

12 Replies

As a newbie investor, I’m conflicted between cash flow vs appreciation potential, especially in a market where everyone wants the highest price and deals are harder to find.

If the cash flow numbers make sense, does it matter if you might pay top dollar for a property in the 2021 market? Once market supply goes up... what if I paid too much... The cash flow is still there, but am I missing the big picture?

Curious on your thoughts, thanks!

@Ethan Brown

My number one goal is always cash flow (preferably with a property that I believe will still have modest appreciation) as it allows me to buy more properties, and since I make steady rent increases each year, my good cash flowing properties turn into extremely good cash flowing properties after a couple years or more which is incredible when you have a lot of properties.  If I was to focus on appreciation, I would likely still have all my eggs in one basket, and it would take me a very long time to save up to purchase another property, and the combination of many small rent increases usually far surpasses the small increase of one more expensive property.  

In regards to your second question on whether it matters if you pay top dollar in a 2021 market, it does matter quite a bit if you are planning to sell or refinance the property in the future if prices were to become stagnant or decrease once supply goes back up and/or interest rates rise quite a bit, but it shouldn't matter so much if you plan on keeping it for the long haul.  The main reason the cashflow is still there during 2021 prices is due to the extremely low interest rates.  This causes the principal and interest portion of expenses to be pretty similar to when prices were lower while interest rates were a little higher.  The cashflow should continue to work, particularly if there is higher than normal inflation which should cause rent prices to increase.

I personally see buying for appreciation a lot more risky now due to the fact that appreciation relies on you to either sell or refinance in the future at higher prices to get the benefits.

@Johnny D. Thank you so much for your thoughts, this helps! I do plan on buying and holding. My concern is finding a “good deal” (buying under market value) in 2021, but it seems to me that if the cash flow is great, I shouldn’t hesitate to start my investing this year. I keep hearing that you make your money when you buy though...

I don’t want to wait in hopes of finding foreclosures everywhere (who knows when that will be) for a bargain if my purchase power is diminished with inflation.

Do you agree? Let me know if you have any other advice, thanks again!

@Ethan Brown

If the cash flow works and you believe in the local market long-term, go for it. It’s tough to predict where the market will go short to medium term but if you have cash flow, it will allow you to hold on for the long term to see appreciation.

@Ethan Brown

I definitely agree you make money when you buy, but this extra money matters a whole lot more depending on what your goal is and how long you plan to hold on to the property. If you are trying to flip a property or BRRRR a property, obviously the price point is far, far more important.

If your goal is long-term buy and hold, the purchase price is still important, but it has to be considered alongside the opportunity cost of the time you wait to find a bargain.  The combined monthly principal and interest savings of purchasing a property for $10k less equates to $45 per month for a 30 year mortgage at a 3.5% interest rate which would total $540 per year ($486 if using a property manager).  You should have no problem finding a starter house that cashflows at least $300 per month, meaning you'd make more cashflow in the first year with a property that costs $10k more so long as it would have taken an extra two months or more to have found the bargain property.  

However, who knows how long the inventory will be replenished again to allow more bargain opportunities.  It could be six months or over a year from now, and each month you wait you are losing out on the opportunity cost of a property that cashflows now.

However, I absolutely understand the desire to still seek the hidden gem, and I don't doubt there are still great bargains available even now if you look hard enough.

@Ethan Brown often people seek more cash flow markets early on in their investing (ie to be able to quit their 9-5 job and transition to REI "full time") and appreciation markets later on (where big money can be made and depreciation can offset high cash flowing investments). Those that don't need money from REI to live on any time soon and don't have a goal to quit their job may prefer to seek an appreciation market right from the start. It all depends on your goals, market you invest in, skill set, overall financial position, etc. In an ideal world you purchase properties that cash flow initially AND appreciate in value and in rental prices over time. Not easy to do. Good luck!

@Ethan Brown This is something that really got me when I started. I was like I want cash flow for passive income, but I also need appreciation cause what happens if the home value drops!

But then I realized, if the day I buy it, it cash flows, and let's say there was a market crash the day after, that is ok. I mean it sucks that I won't have extra equity in a property, but really it does not affect my cash flow. I am still making cash flow.

Let's look at the other scenario. You buy a house solely for appreciation. It does not cash flow, and instead it costs you $200 dollars a month to cover bills since the rent.

But the home increases 10% over the next 2 years. So you gained some equity. You will only get that money if you sell, and then you still need to pay taxes on that (unless you 1031). 

In one case, you have cash flow no matter what and you have to just wait out the drop, the other, you need to pay a bill every month until you sell for some profit down the line.

@Ethan Brown I think you always want to have a property that cash flows because if the market falls, you can wait for it to recover with no real impact to you in the here and now.  However, I think focusing only on cash flow is also a mistake.  I evaluate my properties based on not only the monthly cash flow but also total accretive value added.  

That means I want to know how much equity I gain every month by paying down the mortgage as well as how much appreciation I expect to have.  I think the real money is made through the equity you are building and not the cash flow.  A real world example for me is a property that cash flows $285/month but is gaining $570/month in principal payments on the loan and $900/month in estimated appreciation (3%/yr).  In this example, if you got hung up on the cash flow and chose to walk away from it at $100/month cash flow you would be leaving the $1500/month on the table.

I think there is logic in buying the most expensive property you can that has positive cash flow because you will maximize items 2 & 3 of the equation above.  Of course, I'm not suggesting you overpay for properties, just get deals in more expensive neighborhoods.

I also BRRRR into my deals so the one I sketched out above has an ROI of ~42% if I just consider the monthly cash flow or ~260% if I take equity and appreciation into account.

If you have a cash flowing deal, go for it.  I don't remember the exact quote from Scott McGillivray in his BP podcast but it was something to the effect of "If you find a deal that cash flows, buy that one and buy the next one.  Buy them all!"  Good luck and get going.