Cash flow or appreciation?

[Zhenchen W.]

Hi all, I've been saving up to buy an apartment in NYC where I live and work, but have decided to put the money to better use to invest in rental properties out of state. Complete newbie in real estate investing, and since I have a full time job, my thinking is to get started with a relatively inexpensive turnkey property (~$100k, 20% down) and see how I can scale from there. 

My goal is to accumulate capital so I have more money to invest in more properties in the coming years, how should I think about wanting cash flow vs. appreciation? Ideally, I'd want both, but often one can't have it all, so which is a more effective way for scaling? I think this would help me narrow down the specific markets, and research turnkey providers in those areas. 

Appreciate all your thoughts and recommendations!

ZW.

[Mitchell Roadruck]

Hey @Zhenchen W.! Congratulations on deciding to invest. I would say focus on finding a property that will cash flow well. You can stack the cash flow from that deal + your savings to grow your portfolio on property at a time. You can refi those properties and use that equity to purchase a property in an area that appreciates more but maybe doesnt cash flow as well.

[Jay Thomas]

It seems that in life, when it comes to financial decisions, there is rarely a "win-win" option. It always feels like we're stuck between choosing between two bad options - losing money one way or the other. Unfortunately, this isn't something that can be avoided; it's just a part of life. But with careful planning and budgeting, it is possible to minimize the losses and make sure that you're making the most out of any decision. So when it comes to money matters, don't think about "winning" or "losing"; focus instead on minimizing your losses and maximizing your gains!

[Joe Villeneuve]

Quote from @Carlos Ptriawan:

Quote from @Scott Trench:

I'd rather take a small amount of positive cash flow in a market with great long-term prospects than more cash flow in a market with poor long-term prospects.

this is very true always in general......and then that positive cash-flow is counted after on top of "repair fee" projection.

That's because your CF is too low to start with.  Low CF is just negative CF waiting to happen.  If regular maintenance is turning PCF into NCF, then you shouldn't have bought it in the first place.  When large scale costs (roof, furnace, etc...) turn PCF to NCF, it means you held onto the property too long.

[Matt Greer]

I would absolutely target cashflow first. I would look for an area with stable home prices where you don't have to worry about a drop in value but you can cashflow enough to pay your mortgage and any other expenses incurred by the property and have some left over. I have seen too many new investors overlook cashflow and then become motivated sellers themselves. The gains from appreciation are only realized once you sell the property or refinance which could negatively impact cashflow. Focus on short term stability before you do something riskier.

[Benjamin Aaker]

Quote from @Jon A.:

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

 Yeah. Question should be rephrased as cash flow vs. equity. I don't know any investor who banks on or factors appreciation into his or her numbers. But at the end of the day we're all trying to acquire equity bc equity can always be converted into cash flow. Lots of investments throw off cash. The beauty of real estate is wealth creation.

Great insight Jon. If you ask between cash flow and equity you have a debate. You can have cash flow without equity and you can have equity without cash flow but you need a minimum level of both before your strategy becomes sustainable.
I favor equity but I won't invest if there is negative cash flow. It wouldn't take too many properties like this to run out of money. On the other hand, getting a loan for very little down payment and high cash flow means a very long time paying off a mortgage instead of investing in other properties. And - if you say you'll use cash flow to pay down the mortgage, then you really are just after equity.
I like a mortgage and rent that brings in a little positive cash flow but builds equity. I have a higher likelihood of being able to take out a line of credit for the next purchase and my tax bill is less because my income is less. Go for equity.

[Mark S.]

@Eliott Elias How exactly is appreciation a myth? I sold several properties last year that each sold for over $200k more than I paid for them, including the cost of improvements. Those gains seemed very real to me.

[Randy Gutierrez]

In the current market environment I would 100% prioritize cashflow. If you cashflow properly you will usually always have a hedge against any market downsides, in other other words you can whether the storm. Additionally you can manage setbacks better within your own portfolio. Appreciation usually comes naturally if you analyze your deals right and buy right. 

Appreciation/equity gives you a tremendous amount of leverage to scale, almost feels like a superpower compared to just cashflow. I can refinance a property tomorrow and get 50k in cash. To get the equivalent of that in cashflow it would take me years.

For me, if one is starting out they should prioritize cashflow to mitigate risks, once you have a decent amount of cashflow I would tip the scale a bit in favor of appreciation as you scale.

[Ryan Kelly]

@Zhenchen W. It’s not an either/or debate. You want both. You get positive cash flow by making sure you buy a property that can deliver positive cash flow on an annual basis. This is the spreadsheet side of the equation. You ALSO want to make sure you buy the property in the right market to give you a high percentage chance of appreciation over the coming 5-10 years. These are markets with in-migration and high job growth. That’s the research side of the equation. Cash flow creates a profitable business, appreciation makes you wealthy. You want both.

[Jay Hinrichs]

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

A myth LOL..  appreciation comes in many forms.. its not all gambling and hope..  to me cash flow is the holder while you build real wealth on apprecation.. its pretty tough to do it on cash flow with max leverage and only make 100 or 200 a month and the assets never go up or only go up very little.  better off buying a subway sandwhich franchise LOL

[Dan Heuschele]

Quote from @Jon A.:

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

 Yeah. Question should be rephrased as cash flow vs. equity. I don't know any investor who banks on or factors appreciation into his or her numbers. But at the end of the day we're all trying to acquire equity bc equity can always be converted into cash flow. Lots of investments throw off cash. The beauty of real estate is wealth creation.

 >I don't know any investor who banks on or factors appreciation into his or her numbers.

Ironic because I have used nearly a dozen RE calculators and they all had entries for appreciation forecast.  The key is to be conservative in these, and all, estimates.  

[Dan Heuschele]

Quote from @Jay Hinrichs:

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

A myth LOL..  appreciation comes in many forms.. its not all gambling and hope..  to me cash flow is the holder while you build real wealth on apprecation.. its pretty tough to do it on cash flow with max leverage and only make 100 or 200 a month and the assets never go up or only go up very little.  better off buying a subway sandwhich franchise LOL

 As is often the case 1) I am the contrarian to most responses 2) I agree with Jay.

Ideally you want both.  However, I would take appreciation over initial cash flow every time.  

The reality is initial cash flow has a poor correlation with actual long term cash flow. This is because the RE market is efficient and based on numerous factors. A big one is appreciation. Here is an example, Cleveland has always had better initial cash flow than San Diego. However, core logic shows average SFH rent increase in the last year for San Diego SFH was $700/month. If I purchased a property in both Cleveland and San Diego in 2000, 2010, or 2015 which property do you think had better actual cash flow if there has been no extraction of equity (which would not have been the best decision for ROI)?

Gains from cash flow are taxed annually.  Gains from appreciation are taxed at selling and can be avoided even then (1031 or Re-basis at death).  Many RE investors are in high tax brackets and virtually all aspire to be in high tax brackets.  Getting cash flow taxed at top income tax rates can significantly cut into what makes it to me.  I care more about what makes it to me (after tax) than what I earned before taxes.  I want to minimize taxes.  To minimize taxes, I desire to achieve as much return from sources other than cash flow as I can. 

Prior to achieving a certain financial independence, cash flow may be necessary to pay bills, etc.  Once a certain financial independence is achieved, the cash flow is not as critical and maximizing the total return is what is desired.  

[Jon A.]

Quote from @Dan Heuschele:

Quote from @Jon A.:

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

 Yeah. Question should be rephrased as cash flow vs. equity. I don't know any investor who banks on or factors appreciation into his or her numbers. But at the end of the day we're all trying to acquire equity bc equity can always be converted into cash flow. Lots of investments throw off cash. The beauty of real estate is wealth creation.

 >I don't know any investor who banks on or factors appreciation into his or her numbers.

Ironic because I have used nearly a dozen RE calculators and they all had entries for appreciation forecast.  The key is to be conservative in these, and all, estimates.  

I don't doubt that all calculators have this entry. And if you're a syndicator or someone else trying to convince others to let you invest their capital, you will need to give them projections RE appreciation. But the investors in my network largely invest their own capital, so the primary concern is whether they'll get their capital back in one year, two years, etc. Appreciation often does not get you your capital back in the short-term; rather, it leads to long-term wealth or a step up in asset class when you exit the asset. Keep in mind I operate in NYC so strong long-term appreciation is more or less guaranteed once you find a cash-flowing asset.

[Trevor Naumann]

To mimic what many others have said already. I believe your best bet would be to start with cashflow because it will increase your income which will ultimately allow you to take more "risk" on appreciation later. 

[Devin Peterson]

You only know your best answer based off your situation. If you need to the cash flow I would chase that. If you want to focus on equity growth make sure you do you surrounding area research and focus on the KPIs relative to appreciation and value (jobs, income, employment, etc.) Either way you can't lose!

[Bud Gaffney]

How about both ;)

[Dan Heuschele]

Quote from @Jon A.:

Quote from @Dan Heuschele:

Quote from @Jon A.:

Quote from @Eliott Elias:

Cash flow is real, appreciation is a myth. Shoot for numbers that work RIGHT NOW. I have read too many posts of people who bought too high and can't sell anymore because they thought their property was going to appreciate 

 Yeah. Question should be rephrased as cash flow vs. equity. I don't know any investor who banks on or factors appreciation into his or her numbers. But at the end of the day we're all trying to acquire equity bc equity can always be converted into cash flow. Lots of investments throw off cash. The beauty of real estate is wealth creation.

 >I don't know any investor who banks on or factors appreciation into his or her numbers.

Ironic because I have used nearly a dozen RE calculators and they all had entries for appreciation forecast.  The key is to be conservative in these, and all, estimates.  

I don't doubt that all calculators have this entry. And if you're a syndicator or someone else trying to convince others to let you invest their capital, you will need to give them projections RE appreciation. But the investors in my network largely invest their own capital, so the primary concern is whether they'll get their capital back in one year, two years, etc. Appreciation often does not get you your capital back in the short-term; rather, it leads to long-term wealth or a step up in asset class when you exit the asset. Keep in mind I operate in NYC so strong long-term appreciation is more or less guaranteed once you find a cash-flowing asset.

In my market, and I suspect NYC, appreciation historically has resulted in the return of capital far faster than cash flow. I have purchased at great times and 2 purchases at poor times (value initially fell close to 20%). My monthly appreciation over the holds varies from ~$2k/month (SFH with 32 year hold that value initially fell close to 20% (from $167k to ~$140k)) to ~$15k/month. Note these are all properties of 1 to 4 units. Regardless of when I purchased, the appreciation has out performed the cash flow even on my 2 poorly timed purchases.

I suspect if you calculated your monthly appreciation over your hold period in NYC, you will find that the appreciation has far out performed the cash flow on every property that you hold.  

Good luck

[Jon A.]

@Dan Heuschele Absolutely, I have no doubt that I've acquired the majority of my net worth via appreciation, forced or otherwise. I'm not saying otherwise. What I'm saying is that, when I'm running numbers on a deal, I don't factor in future growth in rent or property values. I wouldn't want the numbers to work based on future appreciation bc, really, none of us have any idea how much properties will appreciate from one year to the next. I've already picked my market based on where I think property values and rents are likely to have solid growth long term. I only buy properties that require substantial value add. Now, as I'm analyzing a property, I'm looking primarily at how quickly I'll get my capital back based on today's rents and values.

[Dan Heuschele]

Quote from @Jon A.:

@Dan Heuschele Absolutely, I have no doubt that I've acquired the majority of my net worth via appreciation, forced or otherwise. I'm not saying otherwise. What I'm saying is that, when I'm running numbers on a deal, I don't factor in future growth in rent or property values. I wouldn't want the numbers to work based on future appreciation bc, really, none of us have any idea how much properties will appreciate from one year to the next. I've already picked my market based on where I think property values and rents are likely to have solid growth long term. I only buy properties that require substantial value add. Now, as I'm analyzing a property, I'm looking primarily at how quickly I'll get my capital back based on today's rents and values.

I do traditionally include both appreciation and rent growth in my pro forma but I use what I hope and believe are conservative numbers. For example, my recent pro forma have not reflected any RE appreciation for the next 5 years in my primary market. This is due to the current state of this RE market more than it reflects my policy. I am still reflecting rent growth. Core logic shows average SFH rent increased in my market was $700/month in the last year. I find it virtually impossible that rents will not be higher next year than today. I expect average SFH rent will increase ~$350/month, but my pro forma is using less than half of that increase.

I will point out rents can fall, vacancy rates can increase, in some markets property tax can increase faster than rent.  This was the case in many markets at the Great Recession (GR) (Detroit, Las Vegas, many Arizona cities, etc.).  My point is the initial cash is not guaranteed to not decline. 

My belief is the pro forma should be conservative.  However, it is not desired to reflect everything in a worse case scenario for purchase evaluation.   Using all worse case numbers would result in no property meeting my buy criteria.  

Good luck

[Chad McMahan]

Quote from @Zhenchen W.:

Hi all, I've been saving up to buy an apartment in NYC where I live and work, but have decided to put the money to better use to invest in rental properties out of state. Complete newbie in real estate investing, and since I have a full time job, my thinking is to get started with a relatively inexpensive turnkey property (~$100k, 20% down) and see how I can scale from there. 

My goal is to accumulate capital so I have more money to invest in more properties in the coming years, how should I think about wanting cash flow vs. appreciation? Ideally, I'd want both, but often one can't have it all, so which is a more effective way for scaling? I think this would help me narrow down the specific markets, and research turnkey providers in those areas. 

Appreciate all your thoughts and recommendations!

ZW.

Hi Zhenchen.
Cash flow is more strategy and math and appreciation is more speculation. I recommend strategy/math.
Speculation is very important. But, ultimately- investing is about doing the best with what's going on.

[Mark H. Porter]

Your target property should be an under rented property needing minimal immediate maintenance work. You want a property that you can raise all the rents on immediately (cash flow increase) without spending a lot of money (NOI increase) which will in turn cause the property to appreciate due to a lower cap.

[Paul Moore]

HI @Zhenchen W.! As an investor I like to listen to the greatest investor of our time, Warren Buffett. If he was a real estate investor, I believe his priorities would be as follows: 

1. Safety of principle

2. Cash flow

3. Appreciation

4. Tax Benefits

And Buffett likes to jump over 1 foot hurdles which means it has to be really simple to understand. In your case, assuming you have a full time career, a 1 foot hurdle would mean you are as passive as you can possibly be. I would look to offload all of the hassle, risk, effort, and everything else on professionals. IMHO this is the best way for you to enjoy your life, maximize your career potential, and still build your real estate income. Happy investing!

[Basit Siddiqi]

It is possible to invest in a property and expect both cash-flow and appreciation.

I normally underwrite my properties to get 8% cash-on-cash return.
I also expect the properties to get a 4% annual appreciation as my market still has annual population increases + jobs coming in.

Just because a property is cheap does not mean it will cash-flow
Just because a property is expensive does not mean it will appreciate.

Best of luck.

[Drew Sygit]

@Zhenchen W.

Beginning investors need to STOP believing all the fluff about rental investing, especially with the overheated real estate market trending to historic norms. Many believe unrealistic assumptions and often apply those assumptions to the wrong property classes.

In our OPINION (always verify yourself!):

Class A Properties:
Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% the more recent norm.
Tenants: Majority will have FICO scores of 680+.

Class B Properties:
Cashflow vs Appreciation: Typically, decent amount of relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% should be applied only if proper research done to support.
Tenants: Majority will have FICO scores of 620+, some blemishes, but should have no evictions in last 5 years

Class C Properties:
Cashflow vs Appreciation: Typically, high cashflow and at the lower end of relative rent & value appreciation. Can try to reposition to Class B, but neighborhood may impede these efforts.
Vacancy Est: Historically 10%, but 15-20% should often be used to also cover nonpayment & evictions.
Tenants: majority will have FICO scores of 560-600, many blemishes, but should have no evictions in last 2 years. Verifying previous 2-years of rental history very important!

Class D Properties:
Cashflow vs Appreciation: Typically, all cashflow with zero or negative relative rent & value appreciation
Vacancy Est: 20%+ should be used to cover nonpayment, evictions & damages.
Tenants: majority will have FICO scores under 560, little to no good tradelines, lots of collections & chargeoffs, recent evictions.

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.