Cash flow or equity: which one actually built your net worth?

Question

Henry Washington broke down an eight-unit he's owned since January 2020 recently on the BiggerPockets Real Estate Podcast. It cash flows fine, and it also went from a $500,000 purchase to a $1.4 million appraisal. His take was that the wealth came from the equity and the appreciation, not the cash flow, and that cash flow is a measure rather than the engine.

Cash flow is the thing most of us were taught to chase. So I want the real answer from people who have held long enough to know.

Look at your own portfolio. Over the whole time you've owned it, what has moved your net worth more: the money that hit your account every month, or the equity you built through paydown and appreciation? And did you buy for the one that actually paid?
(Posting this for the BiggerPockets Investor Brief. Your reply might run in Thursday's edition.)

V.G Jason · Answer

Always equity. Always.

How do you make more in your career? Salary or equity?

Perry R. · Answer

We bought our rentals in the early 2000's with our last 1031 in 2017. Our cash flow is absolutely awful especially once you factor in capex. 1. Bought 1050sq' 3/2/2 in 2005 for $152k. Now worth $390k. Replaced roof/sheathing  $17k. Replaced HVAC $14k. Replaced sewer lateral $14k. Rent is $1250 to long term tenant. House is very dated. Could get $2k per month with $40k in reno costs.2. Bought 4/2/2 in 2004 for $155k. 1031 in 2017. Sold for $280k. Purchased replacement 3/2.5/3 2350sq' $455k. This house is dated but is in a neighborhood of million dollar estates. The house is now worth $900k. Rent is $2250. Could possibly get $3k per month with $150k in reno. I had to replace a very large deck for $40k. Garage doors and openers for $3400.3. Bought 3/2/2 1250sq' for $275 in 2020. This house was an accidental purchase (long story). I renovated myself and contractors for about $55k. It's worth $450k House is rented to a family member and if sold before the end of next year qualifies as sale of primary exclusion. Most of the appreciation came from recent inflation and the properties being located in Nevada. Many think right or wrong Nevada is the place to be. We have a primary not included here.I think there is about $1.1 in equity. We had another house that we sold two years ago before relocating to a state with income tax. Paid $115k and sold for $350k. Paid the IRS $60k in taxes for the sale. There was a lot of depreciation recaptured.

Jay Hinrichs · Answer

Equity hands down.. but cash flow increase over time creates equity.

Marcus Auerbach · Answer

Equity.

Every new investor chases cash flow, I was no exception. But eventually you realize that it will take you a life time to make a million with $200/mo. RE is not very good at cash flow. If you want cash flow, start a biz. Trades and services cash flow, RE is growing wealth. Most cash flow is actually required to maintain RE; capex usually consumes most cash flow: and if your portfolio is in the hood, the math breaks over time: capex will  exceed cash flow.

But cash flow follows equity. Net CF usually comes in at roughly 6-7% of equity for most portfolios. You can test that statement. Every million in equity generates 60-70k in CF. Once you realize that, your next question is: how can I grow my equity?

And BTW: you can harvest equity with refis, tax free actually. With long term appreciation between 4% and 6%, you can harvest 3% every year without increasing your LTV.

Chris Seveney · Answer

Equity. Also have to remember real estate is an asset and the way the government spends money your asset will appreciate (due to the devaluation of the dollar).

Arina Alexiuc · Answer

Cash flow is for capex/opex/PM fee while equity is for me and for generations to come. That's how I see it.

Dan H. · Answer

appreciation has been a larger wealth builder by far than the cash flow for my RE portfolio.

My RE portfolio has appreciated from a low of $2600/month to over $10k/month (3 properties over $10k/month of appreciation) over their hold.   Note the $2600/month was on a $40k initial investment.   One of the over $10k/month was on a ~$140k initial investment.  In comparison, my cash flow, is at its all time high because due to the rate increases starting q2 2022 I have not extracted equity out recently, is less than $1500/month per property on average (I use a 40% expense ratio in my cash flow projection when applied to the entire RE portfolio.).   Including equity pay down it is ~$2400/month per property on average.   So my all time highest average cash flow plus the equity pay down is less than my worse appreciation property has averaged over its hold,

Cash flow does not come close even if I had not extracted money out of the assets to keep the leverage high.

When I joined BP many years ago, the cash flow is king crowd dominated and I was in the minority in my belief that I did not care much about the cash flow as I cared about total return and cash flow was going to be a fairly small contributor to that return.   Today, most of the experienced RE investors recognize that the appreciation (forced and market appreciation) is the bigger wealth generator.

Best wishes

Dan H. · Answer

Oops, equity is $200k (leverage is $809k) so the leveraged cash flow return is far worse than I depicted.

leverage: 80% live, 30 year, 6.75%

1% rent ratio: -$2268/year.   -$2268/$20000=-0.113 or negative 11%

0.5% rent ratio: -$32,268/year.  -32268/$20000=-1.61 or negative 161% return from cash flow.

I, therefore, will update the return from cash flow from very large negative to positive 6%.

Good luck

Jules Aton · Answer

Equity without a doubt.

Cash flow or equity: which one actually built your net worth?

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