Cash Flow or Appreciation: What the numbers say

OP

Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes

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@Jay Y. Good point. My simple comparison ignores rental income growth but just assumes that rental income growth keeps up with expense growth (i.e maintaining constant cash flow).

Jay Y.

Investor · Santa Clara , CA · Member since 2013 · 155 posts · 144 votes

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@Account Closed Something interesting I've observed, and maybe you've witnessed the same thing yourself:

In the Midwest, my properties all experienced the highest CoC returns in Year 1. Over time, maintenance repairs started to become more of a factor, and the rents don't scale nearly quick enough to offset those added expenses.

In the Bay Area, vacancy has been 0% and maintenance... I think I've spent $5 total in the last 2 years on a single bottle of Drano. I've heard from others (as well as from my own experience), many tenants will service minor repair items themselves b/c they don't want to disturb the landlord... Why not? It's a TOTAL seller's market right now and every tenant's biggest fear is an increase in rent!

I'm not saying that the above will always hold true... It more just illustrates what a perfect storm we've got going on in the Bay Area right now. Well, over the last few years... Tech is exploding again... Appreciation, cash flow, low vacancy, low maintenance, easy exit strategy, wonderful location (good schools + lots of jobs), perfect weather... What more could an investor possibly be looking for?

I'm an engineer, but I've learned not to be a numbers guy... If you fixate too much on the math, you might miss out on some "once in a lifetime" opportunities!

10 Reply

Jacobus Bor

Investor · Las Vegas, NV · Member since 2015 · 111 posts · 18 votes

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I have done both, the younger you are the better you are off investing in appreciation as you have time on your side and the return is probably gonna be much higher . the latex i am involved with at present time in self storage in Germany as you have fast appreciation as well as great cash-flow

Matt Mason

Investor · Los Angeles, CA · Member since 2013 · 231 posts · 260 votes

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Originally posted by @Account Closed:

@Jay Y. Good point. My simple comparison ignores rental income growth but just assumes that rental income growth keeps up with expense growth (i.e maintaining constant cash flow).

I think the rental growth is key. If that wasn't part of the equation, then the answer would likely be more weighted to the initial cash flow property. When you model out over 10 years a 4% rental growth rate vs. a 2.5% rate, it makes a big difference. Of course who knows if you will really get a certain rate of growth in rents vs another rate, but you can tell where things are set up for that and are more likely if you do your homework.

My overall view is that pretty much all markets are relatively evenly priced from a macro level when you take all these factors into account. Many markets have higher initial cash flow and probably easier access to discounted deals, while others lend themselves to more forced appreciation plays and just have a higher overall ceiling.

I personally like investing close to home. That would be true if I was still living in Virginia, Indiana or CA. I am not much of one for traveling 2000 miles to deal with directly owned real estate among many other issues of having property so far away, but to each their own. West Coast markets are the big leagues and you have to hustle a lot more with a thin wallet.

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

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Here is something that is usually forgotten, or not appreciated when hoping for a growing market. Appreciation means higher taxes. Higher taxes means lower cash flow. This is one of the reasons why most of the cash returns are frontloaded in the ownership of rental. This is also one of the reasons why I prefer stable markets for rentals...and not crowing ones...and of course not "sinking ships". When you have a stable market, you are better able to raise the rent to control the normal tax increases. It's hard to keep up with both normal and appreciation driven tax increases at the same time.

Kathryn MarchettiPro Member

Flipper · Riverside, IL · Member since 2014 · 23 posts · 18 votes

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I started out always thinking of the future and the appreciation I would gain. Unfortunately, it was 2004 and the market was on fire so my understanding of the market was impaired to say the least. As I continued to learn, I realized that planning for the future is extremely important but relying on appreciation is a crap shoot and I now look for solid cash flow. Just my humble opinion :)

Real Estate Agent · Las Vegas, NV · Member since 2015 · 2k+ posts · 1k+ votes

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I think most investors want the appreciation and rising rents This is exemplified by the major cities,San Fran,NYC ,San Diego, but it comes down to the dollars you have to invest and your location.

Steve Olafson

Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes

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If your idea is to just compare cashflow vs straight appreciation, then you are missing the boat.

In my opinion, the real money is in the "value add" component. This can be done on apartments or commercial properties either through solving income problems or renovations.

The money dwarfs the straight cashflow model.

Another aspect is timing. These "value add" projects can go up exponentially if you can buy when people are selling.

I witness people making millions through single cycles.

6 Reply

Matt Mason

Investor · Los Angeles, CA · Member since 2013 · 231 posts · 260 votes

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Originally posted by @Joe Villeneuve:

Here is something that is usually forgotten, or not appreciated when hoping for a growing market. Appreciation means higher taxes. Higher taxes means lower cash flow. This is one of the reasons why most of the cash returns are frontloaded in the ownership of rental. This is also one of the reasons why I prefer stable markets for rentals...and not crowing ones...and of course not "sinking ships". When you have a stable market, you are better able to raise the rent to control the normal tax increases. It's hard to keep up with both normal and appreciation driven tax increases at the same time.

In most states it does, but in CA and OR there are property tax increase caps (I believe MA has this as well but not sure about other states). 3% in OR and 2% in CA is the max amount your property tax can go up each year, so if you can raise rents at a higher rate, eventually your property taxes will represent a lower and lower % of your rental income and cash flow improves year over year from that.

I agree with Steve O. in that value add and forced appreciation is where the real money is.

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

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@Matt Mason MI has a cap too...right up to the sale. Then the new owner assumes the higher increase in one shot. Do the math.

Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes

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Originally posted by @Joe Villeneuve:

Here is something that is usually forgotten, or not appreciated when hoping for a growing market. Appreciation means higher taxes. Higher taxes means lower cash flow.

You got it cash flow backward! Appreciation means NO increase in taxes! Prop 13 caps our assessed valuation at 2% annually! And I can access that appreciation equity TAX FREE through a refi/Heloc, Repeatedly! Hundreds of thousands of dollars tax free. Repeatedly.

4 Reply

Michael L.

Investor · Lancaster, PA · Member since 2014 · 53 posts · 60 votes

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Unfortunately, too many "assumptions" need to be made to even try to make a calculation.

I don't invest for appreciation because that is speculation.

Investing in cashflowing properties in stable/growing areas is the safest strategy IMHO.

John Thedford

Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes

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I can't pick between one or the other. Like in part of the CA market, we get cash flow and appreciation. I am raising rents this year about 3%. In one instance I just raised the rent right at 10%. This improves cash flow. On the other hand, since 2012 we have had almost 50% appreciation. That is huge in my book. I personally would not consider markets without appreciation...and there are LOTS of houses I would not buy locally because they don't cash flow. They are both important...at least to me.

Ryan Mullin

Real Estate Broker · Indianapolis, IN · Member since 2009 · 575 posts · 496 votes

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Isn't the real issue with the coast property the fact that you have to time the market just right to take advantage of the appreciation..?

@Account Closed

Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes

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Anish,

As Steve and Matt mentioned above, forced appreciation is the way to go in our market. We get both built-in equity and cash-flow. If we buy things at FMV which is likely the case with out-of-state, are we really investing or speculating? Being able to buy with a margin of safety would be great though.

Jay made a lot of good points above, and I'm sure that has been your experience with rentals in our area too. I effortlessly self-manage 17 doors in SJ, mostly single units with a couple of duplexes. It's so effortless that I have thought about opening my own property management company. I leave the apartment buildings to our property manager though. :0)

I love it when people invest out-of-state. That means less competition for me. You have invested in both markets. What do you say? One or the other or both?

4 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

11y

Originally posted by @Account Closed:

Originally posted by @Joe Villeneuve:

Here is something that is usually forgotten, or not appreciated when hoping for a growing market. Appreciation means higher taxes. Higher taxes means lower cash flow.

You got it cash flow backward! Appreciation means NO increase in taxes! Prop 13 caps our assessed valuation at 2% annually! And I can access that appreciation equity TAX FREE through a refi/Heloc, Repeatedly! Hundreds of thousands of dollars tax free. Repeatedly.

Bob. How do you access that equity? With a loan..which increases your monthly cost, and thus reduces your cash flow.

Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes

11y

Originally posted by @Joe Villeneuve:

Originally posted by @Account Closed:

Bob. How do you access that equity? With a loan..which increases your monthly cost, and thus reduces your cash flow.

When my properties appreciate about 9% annually rents have also increased about 6% annually over the last 40 years. At todays rates the increase in rents on just one property will buy me $100,000 every 5 years. Have 5 properties and that's $100,000 cash in yer pocket every year! Sure beats that couple hundred dollars dribbled out every month.

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

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Anish, I think appreciation creates more cash flow over time. I don't see it as an either or deal. The increasing cash flow function is what happens with the appreciating property. As mentioned, if you look at how appreciation can compound cash flow with rising rents, eventually it leaves the 100% straight cash flow play in the dust. Some people speak of 1%, 2% but overtime cash flow after many years of appreciation can go much higher than that.

Some areas have appreciation and some don't. If the area does not then you can make up for some of that missing part with shear volume instead. It is a not a right or wrong question, it is circumstancial and usually historical.

Thanks for posting!

Steve B.

Engineer · Portland, OR · Member since 2014 · 1k+ posts · 1k+ votes

11y

Didn't Sharad from Chicago make this exact same post last year with an accompanying Excel spreadsheet to show roughly the same thing?

@Jay Y. I don't think you are making a entirely logical argument, especially for an engineer. Of course we all realize that investing in San Francisco Real Estate would outperform almost any random midwest cash flowing property but that's using a biased data set to prove the exception to the rule. And if not the exception than certainly an outlier numbers wise.

As @Joe Villeneuve said, your tax consequences will have to be considered when evaluating cash flow vs. appreciation.

@Kathryn Marchetti made a valid point about appreciation being more speculative than cash flow returns on RE. Certainly price is more volatile than rents, so a pecuniary premium has to be considered for that as well. Of course that's much harder to quantify although we all know a risk premium exists and has to be accounted for.

@Matt Mason I'm not sure the math works out that property tax increase affect cash flowing properties worse then appreciation properties. On selling, the current amount and rate expectations of property taxes are an implicit component in the market price. In the meantime we pay some of it perhaps, but most gets stuck to the renters.

Also I'm confused where you are getting your Property rate cap data in Oregon being capped at 3%. Maybe this came from Kitzhabers girlfriend but last year my property taxes here in Portland went up about 10% , per property, on all my properties with the cheaper properties, in the worse areas, being affected even more, per capita, than my ritzier primary residence. So much for the Portland lefts opposition to "regressive" taxes, apparently its ok to tax the poorer neighborhoods at a higher rate when it saves them money on their own home property taxes in inner Portland. Go figure.

At the end of the day I agree with @John Thedford . Any investment in Real estate I make I want both cash flow and appreciation, and I'll sacrifice some of either to get both. However if I was only willing to invest in my back yard I would only buy cash flowing property locally. I've seen too many people on here with seemingly expansive real estate holdings in non-cash flowing markets that in one post talk about how much they own and in another post ask how they can borrow more money or get more equity of of their rapidly appreciating homes. Not a great position to be in if the market dips, and a issue cash flowers don't have as rents are a lot stickier against market movement the the volatility of sales prices.

OP

Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes

11y

@Account Closed I am happy to be in both. Its been an interesting experience. The midwest properties were bought as an investment from day 1. I bought them pretty close to FMV, and turnkey since I dont have the ability to manage the forced value add from a distance. And frankly, the value of the homes is so small, the absolute difference is small anyway. I bought according to my plan of having enough cash flow to pay them off in 10 years and so far it seems a reasonable goal. The end point is fairly predictable. I assume no appreciation but in fact I have seen up to 20% on some of them (supposedly, I will know when I sell) due to fortuitous timing of the purchase. But I did not get them at a big discount at that time.

My Bay Area homes were prior primary residences which we kept as we moved on to other homes. As a result they actually cash flow now since we bought them several years ago and lived in them.

IN terms of effort and time, actually both are stress free for me. I just pay my PM in INdy to handle it all and he does it very well. The local properties I self manage with no issues, like you said.

Projecting 10 years forward I expect to see significant equity gain in both cases (from paydown of mortgage and appreciation) and then I will decide what to do with it. I expect to exit the Indy houses at that time but would likely keep the Bay Area ones unless there is a strong need for the cash. But to put it all in perspective, the equity in the Bay Area homes is 6X that of the Indiana homes even today so my eggs are far more in the Bay Area than the midwest.

OP

Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes

11y

@Ryan Mullin Actually timing doesnt matter. I mean of course if you could pick the bottom consistently you would do great but you dont have to have the crystal ball. I bought my previous home at the top of the market in 2007. At the bottom of the cycle in 2009 the value dropped less than 10%. I know because its a town home and my neighbor sold his out at the bottom. Now the value is about 20% above the 2007 value (not the bottom) and rising every year. So if you hold over a >5 year period, appreciation is a pretty safe bet. Will it cycle again? Probably. But 2009 was a end of the world type event and even then the value dropped less than 10%. So downside risk is low in my opinion.

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

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I think there are misconceptions regarding property taxes in CA. They go down over time as a related expense to the gross in CA not up. This was the legacy left from Prop 13 in the late 70s.

http://en.wikipedia.org/wiki/Oregon_Ballot_Measures_47_(1996)_and_50_(1997)

Matt Mason

Investor · Los Angeles, CA · Member since 2013 · 231 posts · 260 votes

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Originally posted by @Steve B.:

@Matt Mason I'm not sure the math works out that property tax increase affect cash flowing properties worse then appreciation properties. On selling, the current amount and rate expectations of property taxes are an implicit component in the market price. In the meantime we pay some of it perhaps, but most gets stuck to the renters.

Also I'm confused where you are getting your Property rate cap data in Oregon being capped at 3%. Maybe this came from Kitzhabers girlfriend but last year my property taxes here in Portland went up about 10% , per property, on all my properties with the cheaper properties, in the worse areas, being affected even more, per capita, than my ritzier primary residence. So much for the Portland lefts opposition to "regressive" taxes, apparently its ok to tax the poorer neighborhoods at a higher rate when it saves them money on their own home property taxes in inner Portland. Go figure.

I didn't say a property tax increase affects cash flowing property worse than appreciation property. I was responding to another poster who stated that one negative affect of an appreciating property is a much higher property tax assessment.

I don't live in Oregon so I don't know if you had some local increases passed by the voters in the last year that may have resulted in your increases, but there is def. a 3% cap as part of Measure 47 passed in the 1990s.

An example of the benefits are for long time holders of real estate. I have had my primary residence for 16 years. The property tax has gone up about 30% over that time, but the property value has gone up somewhere around 190%. Some of my neighbors pay annual property taxes well more than double what I do.