Cash Flow or Appreciation: What the numbers say

Matt R.

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

Originally posted by @Brie Schmidt:

@Matt R. - I really didn't do a super in depth analysis. Just imputed the portfolio value, current rent/taxes/insurance, and the numbers I mentioned before. There are tons of variables. My appreciation market properties have seen gains way over 5% but I can't anticipate that forever.

Understood. You are a dynamo and busy investor either way! We can revisit these projections later on. Thanks!

Jason Mak

Rental Property Investor · San Marino, CA · Member since 2011 · 398 posts · 144 votes

@Account Closed Great post.

All my property is in Southern California so I guess I'm an "appreciation" guy but for buildings that I have stabilized for several years, they are certainly performing like "cash flow" properties (these are commercial properties). Bonus: when you rehab and "force appreciation".

After reading many many forums on BP, my conclusion is that one must apply a "cash flow" underwriting mindset when investing in those geographies (midwest) and a "appreciation" mindset when investing in coastal geographies. The only mistake one can make is underwriting to "cash flow" in an "appreciation" market (because you'll rarely find a deal that works) or vice versa (because you'll set yourself up for losing money).

As someone investing in "appreciation" markets, the key is NOT to underwrite consistent appreciation but to make sure the cash flow will cover your expenses and find properties that are undervalued or have some type of "forced appreciation" play.

6 Reply

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. - Give me a few days and we can talk about an in depth analysis. I find the topic very interesting as I have both types and similar values. I always told myself I invested in the appreciation market because my long term wealth accumulation would be much greater from it. so I was pretty socked to see it come out so close.

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OP

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

@Charles Worth The rental analysis does not apply to the Bay Area, at least to SFRs. The fraction of homes bought by investors is negligibly small and cannot move the market. You can make cash flow in two ways in the Bay Area. One: buy in foreclousure or auction, rehab and rent out. But in that case you would probably rather flip for better return. Or two: over time through rent growth. But from day 1 its hard to get immediate cash flow without a very large percent down.

Having said all that, the Bay area is somewhat unique. I have friends who got burned in LA buying at the peak of the market and stuck with homes that are underwater and negative cash flow. My experience in the core bay area has been different.

Amit M.

Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes

when looking at the high end markets in the Bay Area (SF, Palo Alto, etc.) you need to realize that prices are pretty much decoupled from incomes. Why?

1- you already have many people who brought years ago and they have tons of equity...I like to call them accidental millionaires ;) most want to stay here and they can trade up easily.

2- there is always a very small amount of properties for sale in these impacted markets. Hence its the marginal buyers who make the difference coming into these markets. And these new buyers have a lot of dough they made elsewhere. Successful small biz folks, tech start up peeps, tech people at large firms (stock options = Chaa-Ching), wealthy foreign buyers, forced appreciation investors like me, etc.

And speaking specifically for the SF market market, I can't say enough about how the cash flow grows. 2BR Units I rented in the fashionable Mission District in 2010 for $2200 are now at least $3600. So yeah, I'm cash flowing like crazy on the bldg. AND the appreciation has also been through the roof. So it's easy for me to pull cash out (which I can pay for with my extra cash flow) and invest in something new. I think old timer @Account Closed was talking about this too. Bob may be a curmudgeon and piss some people off, but guess what? Bob frickin' nailed it!

@Jay Y- hats off to you. You totally get it with the soft numbers and experienc based decision making. Some numbers can be deceiving or counter intuitive. I admit, I get real lazy with numbers these days. I don't bother with stuff like IRR, etc. When people ask me, the answer is "its high." And return on cash? Hell, I don't even know how to calculate that when everything I do is based on borrowed money (pulled from existing equity.) Repairs? "A few hundred dollars a unit." I only know when I round up my taxes. Vacancy? "What's that? Basically zero the last several years. Why bother accounting for it now?" But, I sure as hell spend a lot of time and effort on the soft numbers and all the anecdotal data out there. At least for my market right now that's what really matters.

6 Reply

Dooreuhn Cee

Real Estate Investor · Chicago, IL · Member since 2014 · 229 posts · 171 votes

Originally posted by @Jay Y.:

I also own properties on the coast and the Midwest and I'll elaborate a bit on my own experience...

I don't think it's as straight-forward as to say it's purely cash flow vs. appreciation, pick one or the other. In the Bay Area, yes, I've seen a ton of appreciation, but not just on the value of the home, but the rent as well. So, even if you start off Day 1 in the Bay Area and the property is break-even, it won't take long until the cash flow picks up. I bought a Santa Clara property in 2013 and at the time market rent was $2150. Today, it's about $2600.... and climbing.

I also picked up a home in Indianapolis in 2013, and it was leased up for $1075... Today, it's renting for... $1075... Where will rents be in 2-3 years time? Maybe $1100? So, even though the cash flow appeared more solid on Day 1, it took little to no time for my Bay Area property to catch up and outperform. Not to mention way better tenants, and much easier exit strategy...

What I've really learned is you can't beat location. If you buy in the right areas, you can have it all...

I own in both markets as well.

I moved to the San Jose of the Bay Area in 2001 and my rent was $2,500 and it was a fair market price (dot com boom). In 2002 (or 2003), I renegotiated my rent to $2,150 (dot com bust); although market value was $2,000 the cost of move made me stay. So rent appreciation can be unstable.

Today is, I think, the absolute highest peak that rents have ever been in the Bay Area. Another indicator of possible instability. Better buckle up. I got into San Jose real estate market in 2004 and had a similar experience as you in prices going up up up. You already know the rest of that story.

Finally, the hypothetical presented here assumes $0 equity appreciation in the midwest, along with $0 rent appreciation on the coast, for simplicity. Your analysis only erodes one side of that assumption without acknowledging the fact that midwest properties will appreciate. In fact, IMO, midwest will outpace coastal equity appreciation because coastal markets are back to near peak values (at least in the Bay Area), while midwest homes are still drastically discounted from peak values (in particular the areas that you and I invest).

Therefore, I am personally shying away from coastal markets in favor of midwest cash flow.

Arlen Chou

Investor · Los Altos, CA · Member since 2014 · 942 posts · 1k+ votes

@Dooreuhn Cee do you happen to know what that apartment you were living in rents for now? It would be interesting to know the rate of change over the past 10+ years.

Matt Mason

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

Originally posted by @Dooreuhn Cee:

Originally posted by @Jay Y.:

I also own properties on the coast and the Midwest and I'll elaborate a bit on my own experience...

I don't think it's as straight-forward as to say it's purely cash flow vs. appreciation, pick one or the other. In the Bay Area, yes, I've seen a ton of appreciation, but not just on the value of the home, but the rent as well. So, even if you start off Day 1 in the Bay Area and the property is break-even, it won't take long until the cash flow picks up. I bought a Santa Clara property in 2013 and at the time market rent was $2150. Today, it's about $2600.... and climbing.

I also picked up a home in Indianapolis in 2013, and it was leased up for $1075... Today, it's renting for... $1075... Where will rents be in 2-3 years time? Maybe $1100? So, even though the cash flow appeared more solid on Day 1, it took little to no time for my Bay Area property to catch up and outperform. Not to mention way better tenants, and much easier exit strategy...

What I've really learned is you can't beat location. If you buy in the right areas, you can have it all...

I own in both markets as well.

I moved to the San Jose of the Bay Area in 2001 and my rent was $2,500 and it was a fair market price (dot com boom). In 2002 (or 2003), I renegotiated my rent to $2,150 (dot com bust); although market value was $2,000 the cost of move made me stay. So rent appreciation can be unstable.

Today is, I think, the absolute highest peak that rents have ever been in the Bay Area. Another indicator of possible instability. Better buckle up. I got into San Jose real estate market in 2004 and had a similar experience as you in prices going up up up. You already know the rest of that story.

Finally, the hypothetical presented here assumes $0 equity appreciation in the midwest, along with $0 rent appreciation on the coast, for simplicity. Your analysis only erodes one side of that assumption without acknowledging the fact that midwest properties will appreciate. In fact, IMO, midwest will outpace coastal equity appreciation because coastal markets are back to near peak values (at least in the Bay Area), while midwest homes are still drastically discounted from peak values (in particular the areas that you and I invest).

Therefore, I am personally shying away from coastal markets in favor of midwest cash flow.

Rents are much more stable than prices. I can't comment on the Bay Area specifically, but in Los Angeles, rents dipped just slightly during the Great Recession, at least in the City. This was in an environment where LA County unemployment was around 12% and there were media comparisons between CA and Greece and so forth. It is very rare for rents to fall more than an insignificant amount at least historically in this market.

Eric Zunkley

Residential Real Estate Agent · Los Angeles, CA · Member since 2014 · 32 posts · 6 votes

Originally posted by @Account Closed:

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.

I think there is a risk of deflation in the Mid West. My father's property has gone down in value by 15% over 15 years. The house I grew up in is the same value it was in 1995.

Dooreuhn Cee

Real Estate Investor · Chicago, IL · Member since 2014 · 229 posts · 171 votes

Originally posted by @Arlen Chou:

@Dooreuhn Cee do you happen to know what that apartment you were living in rents for now? It would be interesting to know the rate of change over the past 10+ years.

Best guess is 3k/mo as of 2014, and was back to that 2.5k/mo as of 2012.

Dooreuhn Cee

Real Estate Investor · Chicago, IL · Member since 2014 · 229 posts · 171 votes

Originally posted by @Matt Mason:

Originally posted by @Dooreuhn Cee:

Rents are much more stable than prices. I can't comment on the Bay Area specifically, but in Los Angeles, rents dipped just slightly during the Great Recession, at least in the City. This was in an environment where LA County unemployment was around 12% and there were media comparisons between CA and Greece and so forth. It is very rare for rents to fall more than an insignificant amount at least historically in this market.

Yes, that is exactly my point. You cannot expect rent prices to continue to increase based on a recent jump.

Ronald Hunt

Investor · Indianapolis, IN · Member since 2014 · 113 posts · 21 votes

Cash flow is KING!!

Amit M.

Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes

^ not if its sitting in a savings account earning you 0.1%!

3 Reply

Mark Herrell

Saint Louis, MO · Member since 2014 · 1 post · 0 votes

First off, I'm a multi-family investor so my views are skewed. Capital appreciation is entirely dependent on your ability to grow NOI via rent increases (not always as easy as you think) and cap rate compression (not a safe bet in the times we live in). If you purchase a property with a high cash flow yield "going-in" you can easily come out ahead. For example, a Class B asset in St. Louis can be purchased on the high-end for 7.25%. A Class C asset can be purchased on the high-end for 9.25%. If you grow NOI 3% per year in years 2-5 on the Class B asset, sell at the increased year 5 NOI (cap rate constant), pay capital gains taxes and re-invest in another property, repeating same strategy every 5 years (buy and flip strategy) your IRR will be 9.32% over the course of 25 years. If I buy the 9.25% cap rate property with no increase in NOI for 25 years! the IRR is a straight-forward calculation of 9.25%. If I assume the Class C property has 4X the cap ex requirements of the Class B property over the entire holding period, then I need a higher hurdle rate for the Class C property (10.25% cap rate, likely achieved through reduced operating expenses or raising rents up to market level in year 1) to achieve the same long term returns as a Class B asset. But Mark, how easy is it to find properties with such a high cap rate? It's easier than you think. Many Class C assets are unloved and mismanaged. It's not about the "going in" cap rate as much as what yield you can achieve at the end of year 1 owning it.

In my opinion, if you buy a Class C property and achieve a high enough cash flow yield vs. a class B asset, you should be indifferent to "buy and hold" or "buy and flip" as a strategy. Don't get me wrong "buy and flip" (capital appreciation) is always better than "buy and hold" (cash flow) when you are comparing two exactly alike properties. But when you compare two DIFFERENT properties with entirely different yields there is a point where the two are break-even vs the other (as outlined in my example above). Which has the lower execution risk? In my opinion, the Class C (high cash flow) property. I don't have to rely on raising rents every year, I don't have to rely on cap rates compressing or staying constant, and i don't have to rely on a buyer willing to pay full market value for my property because i'm holding it for 25 years (just an example hold period). I think it's all about risk tolerance. Buying low maintenance, good looking properties in good locations appeals to our need for safety and security in our investments. But looks can be deceiving. Is your safe strategy really safe? Many people who are ALOT smarter than me (think big money, institutional investors) have lost lots of money buying Class A trophy assets in high-growth markets. Just some food for thought. I enjoy the discussion because it's a very basic philosophical question that needs to be answered to chart your long-term investment strategy and ultimately define your success. Best of luck to all!

Jack B.

Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes

Originally posted by @Jay Y.:

I also own properties on the coast and the Midwest and I'll elaborate a bit on my own experience...

I don't think it's as straight-forward as to say it's purely cash flow vs. appreciation, pick one or the other. In the Bay Area, yes, I've seen a ton of appreciation, but not just on the value of the home, but the rent as well. So, even if you start off Day 1 in the Bay Area and the property is break-even, it won't take long until the cash flow picks up. I bought a Santa Clara property in 2013 and at the time market rent was $2150. Today, it's about $2600.... and climbing.

I also picked up a home in Indianapolis in 2013, and it was leased up for $1075... Today, it's renting for... $1075... Where will rents be in 2-3 years time? Maybe $1100? So, even though the cash flow appeared more solid on Day 1, it took little to no time for my Bay Area property to catch up and outperform. Not to mention way better tenants, and much easier exit strategy...

What I've really learned is you can't beat location. If you buy in the right areas, you can have it all...

Quoted for truth.

Diane G.

CA · Member since 2016 · 1k+ posts · 1k+ votes

My $0.02 -

1.Cash flow model seems to require more time and effort... it is not a passive model anymore as compared to appreciation...My experience with my investments in SF, I spend maybe 2-3 hours per month on average, if that much.....

2. Dont over leverage yourself, and you will be fine in the long haul either way....

Joe VilleneuvePro Member

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

My 2 cents.

Learn how money works, and put it to work. When you let your money sit, you lose because you have to do the work to increase your money. When the money is working, you can manage it. It's easier to compound your cash through flips, and then buy into cash flow with the profits. It's also much, much faster...and more profitable.

Most of the argument between CF vs. Appreciation is based on both sides doing both wrong.

Cash flow investors it seems would rather work to generate the cash needed for the next down payment. Then, they leverage the property instead of the cash.

Appreciation investors it seems would rather work to generate those same funds and just bury their money in the equity, hoping (yes, that's the correct word), that the property grows in value. They are leveraging the future. They're not investors, they're speculators...basing their hope on future events they have no control over.

In the end, either way breaks out even, since they're both working instead of their money working. They're both leveraging their time, instead of the money's time. We are only granted 24 hours in a day, while money is granted (if you understand how it works) an infinite number of hours.

To me, the difference is the CF Investors are taking their profits out in pieces, while the Appreciation investors are waiting for the big score.

2 Reply

Diane G.

CA · Member since 2016 · 1k+ posts · 1k+ votes

this really is NOT about which is better, CF or appreciation.... It is REALLY about different locations offer diff business model.... in CA, nobody can CF 99% of the time, the only way is to buy and hold and wait for payday, and it works the last 30 years..... In midwest, not much appreciation, the best way to make money is CF....

So diff location allows diff games

Joe VilleneuvePro Member

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