Cash Flow or Appreciation: What the numbers say

Buying & Selling Real Estate

Cash Flow or Appreciation: What the numbers say

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

There are pages and pages of discussion and opinions on cash flow markets (midwest) vs. appreciation markets (coasts). What I haven't read so far is a simple analysis of the numbers. Since I actually own properties in both markets, here is how I see the numbers stack up. Now remember, this is only the numbers, not counting work, risk, hassle factor etc etc.

Lets consider two hypothetical but typical portfolios. Each is purchases with 25% down and 4% interest rates. The midwest property returns enough cash flow to pay off the mortgage fully in 10 years if all positive cash is reinvested into principle reduction. This is possible and I am doing it on my midwest portfolio.

The coast property lets assume just breaks even even after paying the mortgage on a 30 year basis. Thats common with many coastal expensive markets and probably the lowest return I would accept as I don't want to have negative cash flow ever.

Lets assume we sell both portfolios after 10 years

On the midwest property lets assume 0 appreciation. Your total return over 10 years would be 300%.

If the coastal property would grow at a CAGR of 5% per year, after 10 years your gain would be slightly higher than this at 322%. If it grew at 4% per year it would be slightly less at 265%. So you would need something between 4% to 5% CAGR over 10 years for both these investments to have equal returns.

These are rough numbers, no closing costs etc accounted but I think it makes the point.

So then you look at the risks on either case. Both have risks. Cash flow may not actually be as high as you thought and reduce returns. OTOH, appreciation may also not happen.

On the plus on the cash flow, at least some of it is in my control. The appreciation is a market phenomenon and mostly out of control. And cash flow is independent of value of the asset. It can go down but the cash flow remains. Also equity builds fast and chances of getting upside down is low.

On the plus side of appreciation: Chances are its a lower time commitment and better tenants. Plus it has a better upside. The cash flow is bounded and you can only improve it so much. Appreciation upside is theoretically unlimited. But equity builds slowly and you could end up upside down in a bad market.

So I guess the point is there are pros and cons to both approaches.

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

@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!

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Brie SchmidtBusiness Member
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Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
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I have both types of markets and my portfolio is pretty split between the two.
My appreciation market has afforded me the ability to pull out equity and grow, and long term will provide me with better wealth accumulation.
My cash flow market affords me the ability to replace my income and will provide me with the means to "retire"
I would never sell one for the other and like the balance each provides
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David Dachtera
Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
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Lots of experienced folks here, so may I solicit your feedback?
My take on the appreciation question is that investing for appreciation amounts to speculation, and for that read "gambling". No difference from gambling in the "Wall Street Casino".
By me, appreciation is o.k., but cash flow (income) is what I need to carry me into my retirement years (I'm 60).
May I get your thoughts on those statements?
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
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@David Dachtera From someone one year behind, I agree.
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Jay Y.
Investor · Santa Clara , CA · Member since 2013 · 155 posts · 144 votes
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@Steve B. All I'm trying to say is that numbers can be deceiving so don't just input them into an Excel spreadsheet and expect what you see on screen to mimic reality.
There's a lot of things that go on behind the scenes, things that I had to learn over time by actually doing... and did not initially account for when running my cash flow numbers. For example, 0% vacancy in the Bay Area is not a pipe dream and actually something that does happen! I didn't know that on Day 1... but everytime I list a property for rent on craigslist, there are 5+ offers by the end of the night... This is simply a byproduct of an appreciating market. On the other hand, I didn't know how expensive an eviction is, and how often it can happen in a pure cash flow market, more geared towards working class tenants... who are also higher maintenance.
A lot of local investors have no way of knowing these things in advance when they first run their numbers so they naturally assume that vacancy/maintenance reserves will be the same for both sets of properties. In reality, they won't be.
As @Matt R. pointed out, cash flow increases at a faster rate in an appreciating market. If you only follow the numbers blindly, you will be misled by the seduction of perceived greater cash flow on Day 1, which will be left behind in the dust in Year 5.
Appreciation happens for a reason. You always hear that appreciation is just speculation, so it's better to go with cash flow... But what do you get when you buy into appreciating locations?
-Excellent schools
-Plethora of skilled jobs
-Solid infrastructure (first rate: shops, restaurants, public transportation, entertainment, etc.)
-Wonderful pool of high quality tenants
- Aggressive competition from both homeowners and investors (both foreign and local) trying to get into the market... further driving prices up
Work backwards. Look for areas that give you all of those bullet points, and the odds are very good that you've just found yourself a market that will appreciate in the future.
Properties/markets are expensive for a reason... But as mentioned above, it doesn't have to be either/or. You can have BOTH cash flow and appreciation... that's my plan anyway.
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Jason L.
Real Estate Investor · Chino Hills, CA · Member since 2014 · 47 posts · 19 votes
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@Ryan Mullin
Originally posted by @Ryan Mullin:
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..?
To a certain extent, yes. Furthermore, the penalty for mistiming the market (e.g. downward price movement during a downturn) can vary quite a bit from one micro-market to another out here, as can the rate of the subsequent recovery.
I purchased a property here in California in 2006, just before the market peaked. Toward the bottom of the market a few years later, some of my neighbors foreclosed and their homes were snatched up at about 40% off peak prices.

It's 2015 now, and while my property's value has largely recovered, it still is not worth 90% of my 2006 purchase price. Not quite the same experience that @Account Closed described.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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Originally posted by @David Dachtera:

Lots of experienced folks here, so may I solicit your feedback?
My take on the appreciation question is that investing for appreciation amounts to speculation, and for that read "gambling". No difference from gambling in the "Wall Street Casino".
By me, appreciation is o.k., but cash flow (income) is what I need to carry me into my retirement years (I'm 60).
May I get your thoughts on those statements?
May I get your thoughts on those statements?
That is understandable David. I look at this a a function of location. It is does not really matter if you bet on appreciation, either the location has historical appreciation or not. I suppose if the area did not have a long history of appreciation and you thought it could appreciate that would be speculating. The reality could be we all speculate on cash flow. Vacancies and such will determain what the actual cash flow is. Where as raising rents becomes the reality of appreciation. How much and when you can raise the rents is the speculative part.
In my area I am not expecting more than mid single digit appreciation for many years to come. That would be in line with the historical averages. Keep in mind that could still double rents and value in about 10+ years or so. That is typical for this area. Understand I am looking at decades as an appreciation time frame, not monthly. In that sense, your retirement needs using your immediate cash flow market make perfect sense vs some initial low cash flow play and waiting for the appreciation fairy to come along 10+ years later. Your hedge might be volume vs any expected appreciation.
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Ryan Mullin
Real Estate Broker · Indianapolis, IN · Member since 2009 · 575 posts · 496 votes
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@Jason L. Thank you for that illustration. That was my point... this "appreciation" that happens on the coast is really just market fluctuation. Just because there are wild swings in value and then market corrections doesn't mean that the true value of the property has increased in REAL dollars over time. - necessarily.
The fluctuations IMO add risk. Yeah if you are savvy enough you can see a bubble forming and get out at the right time. But is a bubble forming really considered appreciation..? or just an artificial run-up in values that the market will find and correct.
In the midwest on the other hand I buy a house in 2006 for 50k that rents for 750. After the crash in 09 it rents for 775 (more tenants on the market = increase in demand for rentals). Today it rents for 800. Modest increase. Nothing wild. Did the value of the property fluctuate during this time. Yes... but who cares, the rents are consistent. and increasing at least with the rate of inflation. If I did have to sell in 2010, or 2011 I would have to take a loss... but not 40 or 50% of the value...
Just some thoughts on the subject... obviously I am a midwest buy and hold guy so my opinion is completely biased. :)
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Account Closed
Real Estate Investor · San Antonio, TX · Member since 2014 · 785 posts · 190 votes
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Cash flow for me, I respect all other opinions here. I buy a house for 55-60k, do 5k in rehab and either rent or seller finance it out. 12% cap rate and no maintenance on the seller finance deals. It's less risky than worrying about appreciation and the fluctuations in the market. To each his or her own!
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Jeff S.
Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
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Rental appreciation for me @Account Closed . Most just deal with the market they are living close to and that is true for me too. Have looked into the other markets but just don't want the hassle they bring. Have not relied on RE for a living though.
If I lived in a cash flow market I would be buying it up like crazy and self manage.
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Charles Worth
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
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@Account Closed My problem with appreciation markets is that it is backward looking and for many markets that are considered appreciation markets it might have already happened. Its hard to see how major markets can keep growing without being propped up by artificial demand (i.e. foreign money, speculators, etc.). For instance, in SF the price of a home is now $1MM (median). Assuming a growth rate of 5% a year that would mean that in 10 years that same median home is going to be worth $1.55MM. The problem from my perspective is that even assuming the typical homebuyer makes $180K (well above the median income) in household income and that it grows at 2%. This would mean that today a mortgage at 5% interest would be 35% of income while in 10 years it would be 46.5% of income or almost 50%.
There are also a number of things that could happen to shift many of those people who would have gone to SF to other markets something we have seen with places like Austin esp as employers realize that there is talent there along with major cost savings.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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Charles that is a good point. And that is exactly what happens. In markets like NYC and SF it becomes more and more a place with a majority of renters due to the lack of affordability. The property still could appreciate and rents would go up as less and less can afford to buy. NYC I think has 6 or 7% of the entire nations renters.
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Eric Taylor
Investor · Mission, TX · Member since 2014 · 117 posts · 40 votes
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The biggest difference between cash flowing properties ie 2% rule and properties that appreciate seems to be the price/sq ft with truly appreciating properties costing 5X to 10X more per sq ft than cash flowing properties. Just a thought
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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Charles, I am not sure I buy the artificial demand part. If a buyer plunks down one million in cash, regardless of the origin, there is nothing artificial about that one million dollars. It is 100% real:) and will support that areas comps in a real way.
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Brent Seehusen
Investor · Orange County, CA · Member since 2014 · 137 posts · 96 votes
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Originally posted by @Ryan Mullin:
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..?
Timing it isn't all that difficult though. Investors that were focused on cash flow had no trouble finding deals in prime California markets from 2009-2012, benefiting from nice appreciation since then. The same was true from 1994-1997 and 1984-1987. Anybody buying during these cycle lows has benefited the most from appreciation, but positive cash flow was the signal that told savvy investors when to jump in.
The key to timing the market in California is to wait for a brutal recession to pound real estate into the ground. At that point, owner occupants are afraid to buy because they don't want to lose money and they may not be secure in their jobs. By the end of the recession, investors are the only ones willing to swoop in and put a floor in the market. The reason is because comparable rents make buying prime real estate a good idea and they are willing to take the short term risk of further price declines to lock in a property that breaks even or positively cash flows.
Once the economy turns around, those properties experience dramatic appreciation, but it was the initial focus on monthly cash flow that led to those gains.
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Account Closed
OP
Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
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@Charles Worth Why can't the median price of a SF home be $1.5M in 10 years? The whole city is 7 miles by 7 miles square. Bounded by water on 3 sides. It adds thousands of jobs per year. Many young tech workers live there and commute to the South Bay so actual job creation is even higher. When I bought my first home in the Bay Area for $340K I thought it was insane and how high can it go? But now that looks really cheap. When the housing stock relative to population is so small, median home prices and median incomes become decoupled. You don't need the median income to be $250K to make the median home $1M. Lower income people just rent which helps rental growth also. You would think at some point anyone making less than 100K would simply move but that doesn't seem to happen.
On top of that certain global cities attract global capital. SF is one of those cities. Compared to London, Singapore, Hong Kong etc SF is dirt cheap.
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Charles Worth
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
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@Matt R. your are right artificial demand really just refers to demand that would exist in the absence of something else. I do consider foreign buyers to be part of this because many of them (in NYC at least) are just parking money with no thought to fundamentals. Many do this because of the policies and possible unrest in their country (generally). I guess a better word would have been hot money or speculative demand. My point was really that it is not tied into any type of fundamentals and as such will one day just stop because of something that is again not quantifiable.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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@Charles Worth Right on Charles. I guess I look at this in another way. Those investors look at the planet and select NYC as the place to invest. That is not crazy speculation lacking basic fundamentals in my mind. There are some solid reasons they choose NYC over every other place on the planet. Initial cash flow might be the last reason but that is only part of the bigger picture. Let's face it, parts of NYC are considered some of the most desirable places to live and invest in the world. It is in an exclusive club by itself.
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Charles Worth
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
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@Account Closed I think its a much longer conversation on some of those markets except London but compared to other US markets North Californa dominates the list of expensive list of cities in basically every list I have seen and that Median home price is equal or more than NYC (depending if you want to compare only to certain areas in NYC).
You are also correct and like you I have looked at NYC RE for years and thought the same thing and for many of the same reasons as you stated the prices have kept going up. Also, it's very possible that you are right, the normal metrics have decoupled and prices just keep going up. In addition, I made very modest income projections and its entirely possible that Bay area incomes well exceed this growth rates as more and more work becomes tech based. Yet, it is also very possible that something happens to drop those very rosy appreciation numbers people are relying on and because everyone bought (many with leverage) with those numbers built in, they get scared and prices drop.
With something prices to perfection like that I can definitely see why many people including me would be uncomfortable assuming this type of appreciation baked into the next 10 years which ties back into why some might choose the cash flow markets over the appreciation markets.
As far as rents go, If the property was at $1.5MM you would have to rent it for $13K just to cover the mortgage of $80K assuming 50% in expenses. Much like NYC I assume people start cramming themselves into those spaces but even at 4 people that's over $3K a month or $40K a year with no tax breaks for interest deductions.
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Charles Worth
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
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@Matt R. true but historically people who view it as a parking space either eventually move along somewhere else or find a better investment, just like most of us hopefully don't store money in savings accounts forever.
Not saying that happens tomorrow but if I had $800K to invest in a $1MM property I am not sure I would be so comfortable that would hold up, especially if I was comparing it to being able to earn 15% or more in COC in a cash flow market where the fundamentals make sense. I could easily be wrong about this and overanalyzing it as I am newer than many other more experienced people here.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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@Charles Worth I hear ya Charles. I am new too. Investing is a hassle, paperwork, liabilities, loans, managers, taxes etc. I think it is wise to make it worth the hassle. One question I like to ask on this subject is....when your kids or future kids ask where you invested in real estate back in 2015 - what location do you think they hoped you picked? :)
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Brie SchmidtBusiness Member
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Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
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I have two similar sized portfolios - one in a cash flow market and one in an appreciation market. So I ran my numbers through the rental property calculator to compare.
Cash Flow Market - 8% vacancy, 10% repair/capex, 1% market appreciation
Appreciation Market - 3% vacancy, 10% repair/capex, 5% market appreciation
At the end of 30 years I added up annual NOI and property value
The cash flow market makes up 48% of the total profit and the appreciation market makes up 52% of the profit.
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Charles Worth
Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
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@Matt R. If I knew what market that was beforehand it sure would make life easier. At least in my market it has been markets where 10 years before you never would have wanted to step foot there. Go back a little further and places like Soho, the East Village, etc. were places you never would have wanted to go.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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Originally posted by @Brie Schmidt:
I have two similar sized portfolios - one in a cash flow market and one in an appreciation market. So I ran my numbers through the rental property calculator to compare.
Cash Flow Market - 8% vacancy, 10% repair/capex, 1% market appreciation
Appreciation Market - 3% vacancy, 10% repair/capex, 5% market appreciation
At the end of 30 years I added up annual NOI and property value
The cash flow market makes up 48% of the total profit and the appreciation market makes up 52% of the profit.
Awesome Brie! Thanks for sharing. I have a couple questions on those numbers. How can the 8% vacancy have the same repair expenses when factoring turnover to make rent ready? I would imagine the cash flow market would have more associated cost. On the appreciating market did you account for rent increases along side the 5% appreciation? Gracias senora!
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Brie SchmidtBusiness Member
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Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
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@Matt R. - To make it easy I just kept rent and expenses the same.
My cost of labor is so much cheaper in the cash flow market. For example I pay $30 to have a unit cleaned and $150 to have it painted in the cash flow market. In the appreciation market I pay $130 to clean and $600 to paint - so while the vacancy is 3 times higher, the cost to do business is 4 times lower.
I honestly thought I would make better long term money in the appreciation market. I had never compared the two and was quite surprised that they came out so close.
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Matt R.
Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
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Originally posted by @Brie Schmidt:

@Matt R. - To make it easy I just kept rent and expenses the same.
My cost of labor is so much cheaper in the cash flow market. For example I pay $30 to have a unit cleaned and $150 to have it painted in the cash flow market. In the appreciation market I pay $130 to clean and $600 to paint - so while the vacancy is 3 times higher, the cost to do business is 4 times lower.
I honestly thought I would make better long term money in the appreciation market. I had never compared the two and was quite surprised that they came out so close.
Sweet, $150 that's great. What about the rent increases? And lastly, this scenario has no forced appreciation potential or was that included? I am thinking in some appreciation areas, condo development, conversions, adding square footage, bathrooms etc could be possibilities that the cash flow market has no chance of including those opportunities. Thanks!
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