I am having a little trouble understanding the nuances of a capital growth strategy, as opposed to, say, strict buy-and-hold. I guess I don't quite see specifically what IS capital growth and what is NOT capital growth, with respect to income properties. The way I'm reading it, capital growth is about increasing value. But doesn't paying down a mortgage increase value? Or is it only appreciation and/or repairs/updates/etc. that would be considered capital growth? Is it all about taking properties and trading up to increase value? Is it some combination of these? Or perhaps some of the above is and some isn't?
I'd appreciate any clarification, thanks!
Your net worth will grow whether or not this comes from the appreciation of your assets or an amortization of your debt. A lot of concepts in traditional finance definitions are driven by the more traditional securities industry and don't necessarily apply as well in real estate. At the end of the day what matters are cash flows and those will determine whether or not you actually realize a growth in capital over a period of time.
People generally look more to appreciation for a growth in capital. People seeking capital growth are generally looking to make their money work harder and trade this off against more stable cash flows. Higher leverage and exchanging up allows one to control more assets with less equity and thus supports the capital growth strategy. People generally either exchange up to bigger projects if this is their strategy. They could also refinance and use these proceeds to buy more property.
If your goal is to grow your capital base more quickly a constraint generally is cash. Thus these individuals generally don't want to keep excess cash tied up in projects because it lowers the return on this equity and doesn't allow one to control as many assets as they could if they exchanged, refinanced, or otherwise deployed the capital to a more efficient vehicle for growth.
Capital growth is the buy and hold strategy. Like bryan said. You have the debt pay down and appreciation. A good strategy for capital growth is find a problem, rehab, place tenant, collect rent for a couple years, sale and repeat.
Think California where it is all appreciation is capital growth. Cash flow is the midwest where you get 2-4% on your rent BUT house values don't increase.
@Elizabeth C. , @Bryan Hancock , @Frank R.
Ok, so if I'm understanding this, capital growth is the build up of capital, whether in the form of cash or the value of an asset?
I saw an article on BP that was trying to "debunk" a buy-and-hold myth. I don't remember the author or the name of the article, but he was saying that for buy-and-hold, capital growth is more important than cash flow because by the time the property has no mortgage it will be outdated and in need of major repair. So, he advocated trading up at opportune moments to avoid the issues that may arise from the buy-and-"mold" strategy.
However, he called the 'trading' strategy capital growth and contrasted it against buy-and-hold. Maybe I didn't understand the article completely, though, because I didn't get the concept that buy-and-hold would be considered capital growth.
Ok, I think I understand now. Thanks! I will be sure to post when I have more questions 8~)
Honestly that is why our business model entails buying more expensive appreciating buy and hold assets through leverage. I have found that by taking by 40-50k downpayment and putting it on a 200k house that I am to leverage my money on both the bank and appreciation.
We buy class A houses so we don't need the money "today" but tomorrow. Therefore we are letting time and tenants paying the mortgage to our advantage.
I agree with the above blog article. A lot of these cheap houses, are cheap because they don't appreciation. So if you buy a 20k house and its rents out for $600 (3% rule), you probably will make no money over time.
I don't understand the last part of your post:
"A lot of these cheap houses, are cheap because they don't appreciation. So if you buy a 20k house and its rents out for $600 (3% rule), you probably will make no money over time."
Why is this? I live on Long Island, NY, and, to be honest, the idea of buying a house for $20k seems like a fairy tale (unless you mean distressed beyond repair). But, that aside, if one were to buy that house for cash, why do you say that the buyer probably won't make any money in the long run?
Despite what is bantered about and advocated on BP there is a lot of truth to the notion that appreciation dominates cash flow for long-term rentals. Buyers compete with owner-occupants for bid prices on assets, which from a macroeconomic standpoint inflates prices to levels where the yield is generally non-existent or at the very least is depressed severely. This coupled with easy financing from GSEs means a lot of non-rent-seeking cheap money is chasing assets, which inflates their prices and lowers their yields. Low yields do not correlate well with cash flows and thus those that promote the real estate industry as a great place to invest for the purpose of separating people from their money need a way to overcome objections. Enter most morons in the industry that label "cash flow" as Rent â PITI. If you completely ignore the other expenses you get a drastically different picture about yield than you do if you account for things properly.
What happens on BP is people take rules of thumb to illogical extremes and go guard rail to guard rail. They say that cash flow is ALL that matters and summarily discount the dominant role of capital appreciation in a long-term investment strategy. They also discount real-world problems like what you cite above from some BP article. Functional and economic obsolescence and only a few of the items that are ignored in driving investors to yield-producing properties. A larger problem is that this type of investing is sub-optimal for most investors that start from a modest capital base. People would be far better served by exchanging up and making their limited capital work harder in larger or other properly leveraged deals.
There really is no one correct answer to any of this. People have different goals, risk tolerances, time horizons, initial conditions, job situations, family obligations, etc. How to grow capital is a function of all of these items along with many others like tax burden, etc.
Ok, so what you're saying, from the POV of a beginner, is that investing in rental properties, from the standpoint of RENT alone, is not a wealth building vehicle (due to long term issues), and must instead be coupled with another strategy (or more) that will produce greater capital growth - such as "exchanging up," as you say.
Would be nice if more buy-and-hold articles/posts/books included this little truth (or maybe I just don't read closely enough). Thanks for the clarification!
There is no universal truth. The answer to most general questions is that it depends on circumstances. In general MOST SFR rentals are poor cash flow investments for the reasons cited above.
Liek Bryan states, There is no 1 way to correctly do things. Part of the greatness investing in Real Estate is the flexability and creativity that can acomplished to get a great deal done. There are So many ways to make money.
Personally I started out in a 2 family owner occupied great property. From there I began aquiring multi family properties. My strategy was looking for great properties in great locations that stood out from your typical multi family for 1 reason or another. And yes I have probably paid a bit more for these as a result but I have no regrets. While appreciation was happening in the background my primary focus was cashflow and being tax efficient.
Fast forward 15 years later I have now changed my strategy to single families and condos. I have quite a few multi families all throwing off nice cashflow so I am diversifying with single families and condos. And while the cash flow is not as much as my multis I am OK with that as I am buying solid homes and great pricing so for this leg of my investing, capital appreciation may take the front seat and cash flow is in the backseat for these properties. Don't get me wrong as these properties still cashflow just nto as much as the multi families.
Like the saying goes, you make money when you BUY Real Estate and buying a solid property at a great value really puts the odds in your favor that you should be able to make money one way or another. Learn how to analyze properties for cashflow, plan on a long horizon time line if you are buy and hold, learn your market, network with Realtors who know your market and above all NEVER stop learning!!
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