Appreciation Over Cashflow...Will Get You More Cashflow

Andrew McGuire · 2023-08-02T16:01:03-07:00

I know this title might be confusing but this is what I tell new investors or friends when I meet with them. Cashflow Should Not be the only thing you Consider when Buying Rental Properties. Like many I started my Real Estate Investing Journey obsessed with the idea of Cashflow and gaining my own Financial Freedom. I mean in theory it makes perfect sense, If I could create more cashflow than my monthly expenses. Than theoretically I would be financially free. I wouldn't have to work another day in my life doing things that I didn’t want to do. I think a lot of other new investors come to that conclusion as well. If I could get X amount of rental properties bringing me this amount of cashflow monthly, I'll be financially free. While I think cashflow has its purpose, it’s the way we get to the heavy cashflow and financial freedom that I have a different perspective on. I see this with a lot of friends, beginner real estate investors and others on platforms like Bigger Pockets. As I did my first couple of years, a lot of these investors want to invest in markets that are really cheap to get into but have high cashflow I know friends who bought homes in states like Ohio for 50K, and it rents for $800/month. This easily achieves the 1% rule which means its rents are 1% of the total purchase price. And theoretically this would be a great deal. The problem with these cheap rentals are that when you really start to look at the true cashflow. After all the headaches, maintenance and management issues it doesn’t end up being much. And then when you go to sell the property after you realize that you end up selling it for about the same as what you paid for it. That's why I don't invest in these markets…..for now. A couple of reasons I don't like investing in cheap markets. #1) a lot of times when the rents are lower your property has a lot more issue and headaches with the tenants, they are generally more challenging to manage. Another reason I don't like them is that one repair can completely wipe out your cashflow for the year. If your rents are 1000/month only call it 20% of that is kept from cashflow that amounts to $2400 for the entire year. One repair like a furnace or electric panel will eat up all of that cashflow. Let's cross our fingers and hope that we don't have any issues with larger ticket items like the roof or sewer. I also don't mind putting nice things into a home when it raises the value of the property but in a lot of these cheaper markets that's the thing it doesn’t increase the value. The biggest reason why I don't like cheap markets is because of the appreciation. That's the trade off markets that have a high cashflow right out of the gate typically don't appreciate. If I buy a house for 80K today chances are its going to be about the same price in 10 years if I go to sell it or refinance. So these are some of the reasons I don't like cashflow markets. Now let's talk about what I do like……the high appreciation markets. If you buy properties in these markets, like Phoenix. These markets give you the best chance to build your net worth. Let's look at what happened from 2019 to 2023 in the Phoenix market. If you purchased a home for 300K in 2019 chances are that home almost double in value in the 4 your period up to 2023, that same home is probably worth about 550K today increasing your net worth 250K. That's just one house. What if you owned 5 properties. If each of these properties went up by 250K in value your net worth would have increased $1.25M. Not bad and for most of us that would easily surpass our income over that same period. Now I know its not realistic that home prices double again over such a short period of time but if you look at how much money our government is printing and how bad inflation has been over the last couple of years. Real Estate is a hedge against inflation and inflation is directly responsible for home prices going up so drastically. Do I think home prices will double again over the next 10 years in these high appreciation markets? I personally do believe they will. Now let's take a look at your average home here in the Phoenix market and how you really get a huge monthly cashflow that can not only greatly increase your net worth but also give you the monthly cashflow you need to retire comfortably. If you purchase a home for $550K it will typically rent for $2700 a month which doesn't get you even close to the 1% rule and is likely not going to cashflow. However I would still rather buy this property than the cheap property in the midwest that makes me 200-300/cashflow a month. In 15 years from now the 550K property in Phoenix could potentially be valued at over $1M. Your going to make some great cashflow once its paid off and it is still renting for $4K/month. Now what's that 80K property in the Midwest worth, I don't know but I'm guessing best case $100K to $120K. My philosophy is this, while you are working and making a good income and you don't need the cashflow, you don't need to be financially free right away. I would rather increase my net worth and balance and then take the cashflow later on. It’s not like you will not have cashflow forever, it will cashflow in time. I'm not suggesting that you buy properties that are losing money monthly. What I am suggesting is find properties in high appreciation markets, rent them aggressive strategies such as Airbnb or Room by Room. To where your mortgage and utilities are covered by the rents. Then let the market do the work to greatly increase your net worth. If you want do get financially free buy more homes than you need. If you think it will take 5 paid off homes to make you financially free. Do your best to acquire 10 of these homes. Let the market do the work. Once they’ve increased in value, sell half of them off and payoff the remaining mortgage on the 5 properties you keep In conclusion I don't think you should not only be thinking about cashflow. You should also be thinking about increasing your net worth and balance sheet. We just talked about appreciation, but there is also so many other benefits to owning more expensive real estate. Depreciation being one of them. I do want to say this video was in relation to single family homes. When you are looking at larger multifamily properties. I do think it makes sense to go to these cheaper and higher cashflow markets because of scale and the ability to force appreciation when improving the properties cashflow.

Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

3y

Quote from @Becca F.:

Quote from @Dan H.:

I was in agreement until

>If you think it will take 5 paid off homes to make you financially free. Do your best to acquire 10 of these homes. Let the market do the work. Once they’ve increased in value, sell half of them off and payoff the remaining mortgage on the 5 properties you keep

There goes your leverage. I question how long you been using your approach. The reason I ask is leverage combined with the appreciation is the wealth generator.

Do you know which state has the most investor owned property by percentage? Ca. Ohio that is well represented on BP is near the lowest. My point is many investor realize that appreciation trumps cash flow. The stats demonstrate historically appreciation provides better return for long holds and that investors recognize this.

Good luck

Dan, I appreciate this perspective. I started making 2 extra principal payments on 2 different rentals (at 6.5% and 6.99% rate) because my "sort of financial advisor" (I don't pay him a fee since I haven't bought any funds through him) said if can't find another investment with better return than 6.5 to 7% I should pay down those mortgages. He isn't a real estate investor and thinks I have too much tied up in RE. I have 4 rentals (1 SFH Bay Area, 1 Bay Area multi-unit co-owned with family mortgage free, 2 SFHs in Indy) so I don't think I'm over leveraged. Mortgage on primary residence here. I stopped paying extra principal payments after I talked to a few investors. I'm also looking at the interest payments on those mortgages and are the interest payment part of rental expense tax write offs on those rentals more beneficial than paying down the mortgages?

If I'm trying to retire early from W2 job or reduce it to contract work in 3 to 7 years (3 years is really ambitious), should I be using leverage to acquire more properties or pay down those mortgages? Also my kids would be inheriting properties with mortgages if I don't pay off/pay down any of the mortgages. My thought process was also to save up more funds to buy in Arizona or Nevada in 6 to 12 months instead of buying another inexpensive SFH in Indy right now.

I suspect you have achieved far better than 7% return on all your real estate investments. 7% should be easy to surpass. S&P 500 lifetime is near 10%. Many syndicators have been achieving near 20%. Brrrr can achieve infinite return (all but one of my direct (not counting LP in syndication) RE investments has achieved infinite return.

The lower your cost basis (higher LTV), the higher the return from appreciation.

Have you ever calculated your monthly appreciation on your Bay Area properties. If you have not, I recommend you do so. My San Diego RE has appreciated between $2.8k to over $8k per month of hold. I suspect your Bay Area will be higher than my lowest (both yours will be higher than $2.8k/month).

If it does not stress you, higher leverage historically produces higher return especially in appreciation markets like the Bay Area. However, no level of leverage justifies stress/lost sleep. Therefore the level of leverage that is correct for you can only be determined by you.

Good luck

2 Reply

Twana RasoulBusiness Member

Real Estate Agent · San Diego, CA · Member since 2017 · 1k+ posts · 1k+ votes

3y

@Andrew McGuire I sold my 5 properties in the midwest that were cash flow positive on paper about 2-3 years ago and acquired more properties in San Diego which were initially cash flow negative until adding value to get it to positive. However even my initial cash flow negative properties well out performed my cash flow positive properties in the Midwest. I'm not even accounting for the fact that some of the properties cashflowed on paper only because everything something would go wrong it would wipe out months if not year(s) of cashflow. A roof on a $800k property in San Diego cost about the same as a new roof on a $100k property in another state.

All that said, there are few out of state investors I know that do very well, but those tend to be the ones who have scaled quite a bit. Cashflow should certainly not be the main consideration when looking to purchase a property especially when younger and working. Something very common that is negative cashflow is investing in a 401k so I presume anyone that is 100% again initial negative cashflow does not contribute to a 401k plan.

Compass5122 Reviews

Website View Page

3 Reply

Andrew McGuire

OP

Real Estate Agent · Chandler, AZ · Member since 2022 · 216 posts · 156 votes

3y

Quote from @Twana Rasoul:

@Andrew McGuire I sold my 5 properties in the midwest that were cash flow positive on paper about 2-3 years ago and acquired more properties in San Diego which were initially cash flow negative until adding value to get it to positive. However even my initial cash flow negative properties well out performed my cash flow positive properties in the Midwest. I'm not even accounting for the fact that some of the properties cashflowed on paper only because everything something would go wrong it would wipe out months if not year(s) of cashflow. A roof on a $800k property in San Diego cost about the same as a new roof on a $100k property in another state.

All that said, there are few out of state investors I know that do very well, but those tend to be the ones who have scaled quite a bit. Cashflow should certainly not be the main consideration when looking to purchase a property especially when younger and working. Something very common that is negative cashflow is investing in a 401k so I presume anyone that is 100% again initial negative cashflow does not contribute to a 401k plan.

I wholeheartedly agree. Midwest for multifamily 100% but for single family…not sold on it.

0 Reply

Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

3y

Quote from @Sam Yin:

@Travis B.

Ditto!!!

There are many approaches. There is no one perfect approach. This topic has been discussed often. It's nice to see more people thinking about it.

Travis said something profound... if you love your job, then it will be great for you to wait decades to achieve FI from your appreciation strategy. However, for those of us that want freedom quicker, the appreciation strategy that has been laid out is not the answer.

Then the question is: do you want your time freedom now at an able young age, or do you want it a few decades later when you are not as able and not as young?

Easy comparison, 2 to 5 years of investing intentionally for cash flow and be free of W2 OR 20 to 30 years of investing for appreciation while working W2? Which is more worth it to you, the cash flow investment strategy that allows you to have the freedom to transition to appreciation later WITH the freedom of time meanwhile? OR the W2 that you love for the next 20+ years to get to time freedom? Then at the end of the day, will your children (if that's your 'why' like mine) appreciate and be able to carry on the generational wealth??? If you were never free enough to fully influence them in their childhood years??? Or do you think that after 20+ years of sacrifice to build wealth you will have any influence on the adult they became as they were influenced by societal norms?

These are questions people may not have asked themselves. Only you know what the right answer is for YOU. As for me, and a few others that I have read from on BP, investing for cashflow now to get to FIRE sooner is the answer. When I made the conscious choice to go down this REI path, it took a few years to get to FIRE. I get to spend ALL DAY with my family if I want to and I'm still investing for generational wealth. But there is no W2 holding my time down. Had I gone the other way, I might likely create even more wealth because my W2 would have supported my investments longer. I chose the first path for my family legacy.

Case Schiller reports top total return (appreciation plus cash flow) for large cities for residential real estate since 2000. I am not sure when I first saw the data but my guess was it was 2013. The top 3 cities when I first saw it, and I believe every year since, has been San Francisco, Los Angeles, and San Diego. This implies in ~13 years not only did the the total return for San Francisco beat the average cash flow residential market, but it beat every cash flow residential market (larger cities only). In addition, I do not know how many years before I saw it was a high appreciating market already the top return market. My point is this is a lot less than 20+ years. Also in ~13 years (possibly less) it surpassed all of them, how many years to have surpassed the average (I suspect less than 10 years).

I will go even further, my worse appreciating property has averaged over its hold more return from appreciation than high cash flow markets produce in cash flow. This implies that on the average year, the high appreciation market will produce higher total return. My worse appreciating property has produced over $2.1k/month appreciation over its hold (current worth ~$950k, purchased $167k, 29.5 years). My best are near $10k/month of appreciation.

I am not implying you cannot do well in cash flow markets (you can do great), but historically the appreciation markets do better and it takes far less than 20 years (likely less than 10 years).

I do want to be leery about using history to forecast the future. historical performance may have poor correlation to future performance.

Good luck

3 Reply

Sam YinPro Member

Los Angeles, CA · Member since 2021 · 584 posts · 738 votes

3y

Quote from @Dan H.:

Quote from @Sam Yin:

@Travis B.

Ditto!!!

There are many approaches. There is no one perfect approach. This topic has been discussed often. It's nice to see more people thinking about it.

Travis said something profound... if you love your job, then it will be great for you to wait decades to achieve FI from your appreciation strategy. However, for those of us that want freedom quicker, the appreciation strategy that has been laid out is not the answer.

Then the question is: do you want your time freedom now at an able young age, or do you want it a few decades later when you are not as able and not as young?

Easy comparison, 2 to 5 years of investing intentionally for cash flow and be free of W2 OR 20 to 30 years of investing for appreciation while working W2? Which is more worth it to you, the cash flow investment strategy that allows you to have the freedom to transition to appreciation later WITH the freedom of time meanwhile? OR the W2 that you love for the next 20+ years to get to time freedom? Then at the end of the day, will your children (if that's your 'why' like mine) appreciate and be able to carry on the generational wealth??? If you were never free enough to fully influence them in their childhood years??? Or do you think that after 20+ years of sacrifice to build wealth you will have any influence on the adult they became as they were influenced by societal norms?

These are questions people may not have asked themselves. Only you know what the right answer is for YOU. As for me, and a few others that I have read from on BP, investing for cashflow now to get to FIRE sooner is the answer. When I made the conscious choice to go down this REI path, it took a few years to get to FIRE. I get to spend ALL DAY with my family if I want to and I'm still investing for generational wealth. But there is no W2 holding my time down. Had I gone the other way, I might likely create even more wealth because my W2 would have supported my investments longer. I chose the first path for my family legacy.

Case Schiller reports top total return (appreciation plus cash flow) for large cities for residential real estate since 2000. I am not sure when I first saw the data but my guess was it was 2013. The top 3 cities when I first saw it, and I believe every year since, has been San Francisco, Los Angeles, and San Diego. This implies in ~13 years not only did the the total return for San Francisco beat the average cash flow residential market, but it beat every cash flow residential market (larger cities only). In addition, I do not know how many years before I saw it was a high appreciating market already the top return market. My point is this is a lot less than 20+ years. Also in ~13 years (possibly less) it surpassed all of them, how many years to have surpassed the average (I suspect less than 10 years).

I will go even further, my worse appreciating property has averaged over its hold more return from appreciation than high cash flow markets produce in cash flow. This implies that on the average year, the high appreciation market will produce higher total return. My worse appreciating property has produced over $2.1k/month appreciation over its hold (current worth ~$950k, purchased $167k, 29.5 years). My best are near $10k/month of appreciation.

I am not implying you cannot do well in cash flow markets (you can do great), but historically the appreciation markets do better and it takes far less than 20 years (likely less than 10 years).

I do want to be leery about using history to forecast the future. historical performance may have poor correlation to future performance.

Good luck

I must agree ith you Dan that in high appreciation markets, the buy and hold strategy is solid. It seem to always make more on the appreciation than the cash flow.

Although cash flow is not my primary focus/strategy, it does play an important part in my game plan. For me, it needs to cash flow to keep the business running on it's own AND to buy my time back. I seek out undervalued and deferred properties for the opportunity to force the appreciation. I exchange as soon as I see the opportunity.

My recent exchanges have been between 6 to 24 months. During that time, the appreciation took over the cash flow by 5 - 10X. If I have a property that might have longer legs, I may consider the long term hold and squeeze out the appreciation later. But for now, as a beginner, I'm in a growth phase. I plan to transition into a hold phase within the next 5 - 10 years. At that point, I hope to move the equities into major coastal areas.

If I can pick up about 50 - 100 rentals within 5 miles from the beach, at 50% LTV or less, near the coast of LA, San Diego, or San Francisco, that would be golden. That many units, at 50% LTV or less, there should be adequate cash flow to sustain the properties AND live off of cash flow. That is an end game I would want to pass on to my kids, if they prove they can handle it.