Cash Flow vs. Appreciation

Starting Out
18yFollow

Cash Flow vs. Appreciation

Will BarnardPro Member
Moderator
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes

Many have argued/claimed here on BP that cash flow on residential properties is of vital importance and investors can not put food on the table with appreciation. I disagree. Once you have built a business with many rentals, you could sell one or two, or as many as necessary each year grabbing the gains from it to live off. This is not to say that you should not have positive cash flow on residential properties, you should. Only to say that it is not the only income source form the property.

Another claim is that you must buy at huge discounts to turn a profit in residential RE. Although I agree getting a huge discount is advantageous, it is not the ONLY way. Just because you buy a sfr for $30k and it appraises for $50k, does not assure you have 40% equity, nor does it assure you will turn a profit on the sell down the road. In fact, in many cases, the $30k you paid is all it is really worth and the so called equity in that area will vanish. What is important is the demographic studies: Strong diverse economy, strong job grwoth, improvement in infrastructure, strong potential appreciation, reduced vacancy trends, ratio of supply & demand, and an undervalued market.

I have read here that some buy in lower income areas at 60% of the current value in places that show poor demographics where population is decreasing and jobs are leaving. So just because you can buy at 60% of value today and turn positive cash flow, does not assure a profit down the road. Who will rent the unit when the supply beats demand and when there are no jobs.

I understand and believe that becoming wealthy from cash flow on residential properties is most likely not going to happen. True wealth is obtained from the appreciation and many tax benefits from residential RE investing. Although I beleive in cash flow, and always strive for it, the true ultimate goal is to eventually sell the residential property for large gains and defer/avoid taxes as permitted by law.

Commercial property is where wealth and long term residual income lives. When purchasing a commercial property, in essence, you are buying the cash flow. In fact, it is valued based on it's performance and not what the unit down the street sold for (comps) like residential is.

Podcast Guest on Show #130
3Reply
165 views

Most Popular Reply

Timothy W.
Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
18y
Originally posted by "SROC4":
Or was it house rich but cash poor? :)

I think we're all cash poor.....lol. At least that's what I've seen with 99% of investors for the first 10 years. I've got a nice "pay day" coming up this weekend and already have the closing set up for next friday where I get to wave bye bye to all of it...lol For me, anything but positive cashflow just isn't an option for long term survival.

Honestly I know of one person who has the financial backing to take 6-10 years of negative cashflow. She's a multimillionaire heiress who already started is operating 3 businesses that cashflow extremely well and has an incredible mind for money (I need to marry this girl). In her case she's buying prime beachfront property now that doesn't cashflow well but she's getting it at 60-70 fmv and is playing speculation. If you're in a position to inherrent a fortune and have 3 businesses that are cashflowing very well, by all means go for it.

And btw, thank you Mike.

Tim

1Reply
See this reply in the discussion

182 Replies

Jump to latestLatest
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "MikeOH":
    So the choice is really:

    1. little or no equity and negative cash flow, but the hope of significant future appreciation

    2. significant instant equity and positive cash flow, but little chance of future appreciation beyond the inflation rate


    Aren't the choices really:

    1. negative cash flow but a likelihood of strong appreciation

    2. positive cash flow but a likelihood of low appreciation?

    Shouldn't you really be comparing retail with retail, or discount with discount, for a valid reflection of the difference between a focus on appreciation or income?

    Mike, isn't it also possible that a property with significant future appreciation prospects also has significant prospects for increased rentals, and thus the likelihood of being cash flow positive for the vast majority of a 20-year ownership period? Many investors are willing to accept a negative cash flow for the first 4 or 5 years, but after that time, the property usually becomes cash flow neutral to positive with market movement.

    I now try and find areas where I anticipate high growth, then seek positive cash flow opportunities in those areas. I would never take positive cash flow instead of growth prospects; the cash flow just provides enhanced ability to wait for appreciation. But to be wealthy from cash flow alone, I'd have to be a full-time property manager, and that's a job, not an investment, IMHO. It may be a well-paid job, but it's still way too active for me; it seems to me that the effort required to earn $1 of positive cash flow far exceeds the effort required to earn $1 of appreciation. :wink:

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y
    Aren't the choices really:
    1. negative cash flow but a likelihood of strong appreciation
    2. positive cash flow but a likelihood of low appreciation?
    Shouldn't you really be comparing retail with retail, or discount with discount, for a valid reflection of the difference between a focus on appreciation or income?

    My comments are about the United States, I don't know anything about the real estate market in Australia.

    However, in answer to your question, no - you can't compare retail to retail because it is nearly impossible to have positive cash flow when you pay retail. So, instant equity is the reality when you buy a property that cash flows. Likewise, negative cash flow is the case when you pay retail. In addition, negative cash flow certainly doesn't mean that there is a likelihood of strong appreciation. Moreover, appreciation depends on your timeframe. If you invested in a negative cash flowing, no equity property in California in 2005, how are you doing today? Upside down and still suffering from negative cash flow (if you can afford to hold the property).

    No. While rents do generally tend to increase over time, operating expenses do also (as do adjustable rate mortgages). In the current environment, rents are actually going down in many areas and expenses are far outpacing rent increases in other areas.

    Look at California, Florida, or any of the other places that have had significant appreciation here in the US. Rents have NOT kept up with the rise in prices - not even close. That's why these areas are such poor areas to own rentals.

    Again, you're trying to separate things that are inseparable in the real world. In the US, you won't have cash flow unless you have instant equity. So, the idea that you'd be gaining wealth from the cash flow alone is incorrect. In reality, the cash flow pays the bills and allows you to grow the business. The wealth comes from the equity you receive at closing (buying a cash flowing property) and the principal paydown by the tenant through his rents (and of course any appreciation).

    So, the choice is really between gaining wealth in the future through appreciation or gaining wealth today through buying at a discount.

    Mike

    0Reply
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "MikeOH":
    no - you can't compare retail to retail because it is nearly impossible to have positive cash flow when you pay retail. So, instant equity is the reality when you buy a property that cash flows. Likewise, negative cash flow is the case when you pay retail.

    Thanks, Mike, for explaining. :D

    I'm considering purchasing properties in Texas, at retail, with NOIs of 10-11%; are you saying that wouldn't cash flow? :shock: Or would you consider that an anomaly?

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    NOI's of 10-11% of what? Yearly NOI's or monthly NOI's? Post the numbers and I'll give you my opinion. What are the monthly gross rents and purchase price?

    Mike

    0Reply
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "MikeOH":
    NOI's of 10-11% of what? Yearly NOI's or monthly NOI's? Post the numbers and I'll give you my opinion. What are the monthly gross rents and purchase price?

    Excuse me; as the figures were quoted that way on the realtor's website I assumed this was a well-understood terminology.

    Example: purchase price $100K, gross rental income $20K, expenses (property taxes, management, repairs, vacancies etc) $10K, net operating income before income tax and interest: $10K

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y

    NOI in this case is $10K. With the $100,000 purchase price, that's a "cap rate" of 10%.

    If this deal really looks like this:

    Purchase price: $100,000
    Rent: $1,666
    Expenses: $833 (50%)
    NOI: $833
    P&I payment: $665 (7%, 30 year fixed on $100K)
    Cash flow: $168

    This looks like a pretty good deal to me.

    However, if this is really retail, you may be able to do better still. And of course you must do your own due diligence and be sure you can really get that rent and those expenses are realistic. 50% is an expected case if you do things right. Worst case could be much worse.

    0Reply
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "Wheatie":
    NOI in this case is $10K. With the $100,000 purchase price, that's a "cap rate" of 10%.

    Quite right; that's what I meant. Sorry, my mistake - still learning the language!
    Originally posted by "Wheatie":
    If this deal really looks like this:

    Purchase price: $100,000
    Rent: $1,666
    Expenses: $833 (50%)
    NOI: $833
    P&I payment: $665 (7%, 30 year fixed on $100K)
    Cash flow: $168

    This looks like a pretty good deal to me.


    That's right. And I thought it looked a good deal, too.
    Originally posted by "Wheatie":
    However, if this is really retail, you may be able to do better still. And of course you must do your own due diligence and be sure you can really get that rent and those expenses are realistic. 50% is an expected case if you do things right. Worst case could be much worse.
    Yes, I hope I can do better, and I sure will do extensive due diligence. :wowie:

    Thanks, Wheatie.

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    Is this a SFH or a multi-unit building?

    0Reply
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "MikeOH":
    Is this a SFH or a multi-unit building?

    Multi-family (duplex).
    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y

    I had assumed SFR. Not quite as good as a duplex, since you have two tenants. Not quite up to the $100/unit goal. Not bad in my book, though. However, I strongly recommend you learn the area and the market before jumping in.

    Cap rates and other commercial factors aren't used much for single families and even for duplexes.

    0Reply
  • Tracey B.
    Real Estate Investor · QLD · Member since 2008 · 67 posts · 5 votes
    18y
    Originally posted by "Wheatie":
    I had assumed SFR. Not quite as good as a duplex, since you have two tenants. Not quite up to the $100/unit goal. Not bad in my book, though. However, I strongly recommend you learn the area and the market before jumping in.

    Cap rates and other commercial factors aren't used much for single families and even for duplexes.


    I was simplifying things; there are actually 24 doors (12 duplexes) with on-site management and I'm considering buying the whole complex, and all dollars are proportionally much larger. The cash flow comes in at under $100 per door but I'm happy with any positive cash flow, allowing me to hold it for the long term whilst it appreciates (as my research suggests it will). I'm not relying on cash flow from my investments to live off; I have other sources of income.

    I confess I've not heard of $/unit being used. Wheatie, if you had to invest $1M on 1 door and it was $100 cash flow positive per month, would that be the same to you as if you'd spent $100K on 1 door to get $100 per month? Or are you just thinking of a minimum absolute dollar figure that justifies your management effort?

    If the latter, my costs already include payment for three :shock: layers of management (on site plus a property management company, plus a trusted local friend to keep an eye on the other two :wink:), and thus I'd hope to be relatively hands-off. Surely in such a situation the return on capital is more important than $ per door, no?

    And yes, I plan to spend considerable time on the ground before plunging in!

    Thanks so much for your helpful advice. 8)

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y

    Coming up with the right set of metrics for real estate is complex. Real estate is a leveraged investment. Real estate is also an active investment, meaning you're far, far more involved with it than with most investments.

    The $/door metric is a way to consider the effort associated with each tenant. Every door means a lease, a vacancy to be filled once in a while and a potential problem if things go wrong. With one tenant, you might a problem. With 24 tenants, you can just about count on having a problem fairly frequently.

    If I had to invest $100K to earn $100/month, I'd look for better investments. That's $1200/year, or a 1.2% cash on cash return. I can do much better in CDs with much less risk and much less hassle.

    If, on the other hand, I can acquire a property worth $100K with an actual cash outlay of $5000, then my cash on cash return is 24%. That's much more attractive. Even a 5% appreciation returns me $5000, or 100% of my investment. Vs. buying outright, I get only a 5% return.

    If I was investing one million, whether cash outright or leveraged, I would expect similar return rates, so proportionally higher numbers.

    Appreciation is never guaranteed. That's the topic of this thread. Investing for appreciation is more speculative than investing for cash flow. I try for a mix, so to me this seems like an acceptable deal, if there is a real appreciation potential. That is, something is happening in the area that's creating jobs, population growth, and demand for housing.

    I think you said this is TX, which probably means oil related. Do realize that's a boom and bust business. If you're being driven by a relatively simple oil field that's near the beginning of its production life, you may be in good shape for growth. Even then, realize there's a build up phase where all the wells are drilled, then activity drops back to a more consistent level. If this is something more speculative (like the oil shale mentioned above), then it may or may not pan out. Oil shale's driving a lot of RE activity here in CO. It did once before, then went bust.

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    That's what I thought. In my opinion, this is a just a fair deal with a cash flow of $84 per unit per month. Having multiple unit generally decreases the quality of the tenants and increases the risks of tenant related expense.

    If (and that's a big if) the numbers are right and this truly is a retail deal, then you can do better. Why would you pay retail when a little work will produce a deal that can be bought substantially below retail?

    The 50% rule certainly does not include paying for 3 layers of management, so you should plan on expenses being higher than 50% if you're paying for all those layers of management (and of course a lower cash flow).

    I also agree with Wheatie about appreciation. The United States is in for some very tough times in the coming years. We have a huge bubble of "baby boomers" starting to retire and the country does not have the money to pay for their entitlements. The government is simply printing money from thin air, which ALWAYS results in inflation. If oil prices stay high, the economy could easily collapse. The only point being is that I wouldn't count on runaway inflation.

    Having said all that, it seems like you're on the right track. If everything turns out to be as stated, this isn't a bad deal.

    Good Luck,

    Mike

    0Reply
  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    18y

    90 replies and over 4200 views in just three short weeks! Just as I suspected, a very hot topic!

    For both newbies and seasoned investors alike, keep in mind that regardless of anyone's opinions posted in this thread, there is not just one way to do things or one way to operate a business. This is just one of the many wonderful advantages to RE investing. :superman:

    As I have said many times, you do not "have to" trade cash flow for appreciation. You do not "have to" be a hands on landlord. The landlording business is not defined as an investment with positive cash flow. Speculation is not defined as gambling, guesswork, or prayers. Forced appreciation is not defined as buying at a discount, rather improving the income and/or decreasing the expenses and thus increasing the NOI is a form of "forced appreciation.

    Owning rental property with the intent to hold while having tenants is a landlord business regardless of positive, even, or negative cash flow. The market, the area, the entrance strategy, the exit strategy, etc. all make up the vast differences and variances you may choose to have in your investment and in your landlording business.
    The choice depends upon each individual investor, their goals, there individual strategies, their abilities, etc.

    Podcast Guest on Show #130
    1Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free