Does the cheap-house cash flow premium survive once you net in appreciation?

Question

A while back I looked at why one ZIP out-yields the ZIP next door inside the same

metro, and it came out almost entirely as a price story: the high-yield ZIP is

high-yield because the house is cheap, not because the rent is strong. The obvious

pushback is the one every cash-flow skeptic makes: cheap houses appreciate slower,

so you give the yield premium back on the value side. A yield trap. So I tested it

against current data, gross yield plus trailing appreciation, roughly 8,300 ZIPs and

695 metros.

The skeptics are partly right. Within a metro, higher-yield ZIPs really do

appreciate more slowly than their pricier neighbors, clearly negative. Sort each

metro's ZIPs into yield quintiles and the low fifth appreciated around plus 1.8

percent over the trailing year while the high fifth was around minus 1.1 percent.

That give-back ate roughly 58 percent of the yield premium.

But only 58 percent. Gross yield ran from about 3.8 to 8.8 percent across the

quintiles and total return still climbed from about 5.6 to 7.6 percent. A partial

trap, not a full one. About 42 percent of the premium survived.

The exceptions are the tell. In 79 of 87 metros the premium survived. In 8 it fully

collapsed, and those 8 were the expensive, compressed markets. San Jose was the

cleanest: the yield spread between its cheapest and priciest ZIPs is only about 2.8

points, but the appreciation give-back was about 6.7 points, so the high-yield ZIPs

lost by almost 4 points of total return. San Francisco, San Diego, Los Angeles,

Providence, Miami, Salt Lake City, and Atlanta rounded out the eight. Contrast the

survivors, all cheap-basis markets with wide within-metro yield spreads: Birmingham

had an eleven-point total-return edge for its high-yield fifth even after the

give-back, St. Louis about eight, Baltimore and Rochester about six. So it is really

a rule about spread. Wide yield spread, the premium survives. Compressed at the top,

it does not. I am naming both the survivors and the traps on purpose, because this is

a description of how prices are distributed inside these metros, not a buy list.

I stress-tested the snapshot, since trailing 12-month appreciation in a cooling year

is a weak proxy for a hold. The negative relationship held at 3 and 5 years, same

sign, just milder. And over a real 2023 to 2026 hold, annualizing actual home-value

growth, the premium survived more clearly, not less, about a three-point edge.

Two honest limits. Only about a third of ZIPs carry a usable rent index, so this

skews denser. And it is all gross and backward-looking, no financing or costs, so it

does not forecast your return.

What I am chewing on: in your own buys, when you took a high cash-flow cheap-basis

property, did the slower appreciation actually show up over your hold, or did the

cash flow carry it? And in a compressed high-cost metro versus a cheap one, do you

screen differently given the spread point?

David

Stuart Udis · Answer

Agree with what Jason is saying. The lower cost real estate is disproportionately impacted by capex and opex. The real estate is rarely sustainable. The spread sheet cash flow is often a product of deferred maintenance and deferred cap ex, not the realities of today's cost of real estate ownership and certainly not the result of a well performing property. The real estate can't absorb the costs. If cash (rent) in and expenses and cap ex out are viewed through a lengthier time period, in most instances the better situated real estate experiences better cash flow, especially if you operate the real estate correctly. This is on top of more predictable and more consistent appreciation.

Jason Cory · Answer

@David Walters

I'm a broker & I run a property management company here in Birmingham. I manage in the exact zips your data is flagging as high-yield. You named Birmingham as one of your survivors — the 11 point edge on the high-yield fifth — so let me tell you what that number looks like from inside it. The premium survives on your spreadsheet. It does not survive in the P&L. And the reason is a concept most investors never get taught: Highest & Best Use.

Highest & Best Use is the test for what a piece of land is worth. Four filters — legally permissible, physically possible, financially feasible, & then the one that sets the ceiling: maximally productive. Whatever use of that dirt throws off the most money is what the land is worth. Value flows down from that ceiling. It does not build up from the rent.

Here's why that wrecks the yield read. A property is two things stacked — land & improvement. The improvement is a wasting asset. It depreciates every single day, roof, systems, envelope, all of it marching toward zero. The only thing that appreciates is the land, & land only appreciates when its highest & best use rises. A higher use moves in, demand pushes the dirt up. That is what appreciation actually is. It's not the house getting more valuable. It's the ground under it getting a better job.

Now go to your high-yield zips. Take Ensley. Renting the house typically works there — but not because it's appreciating. It works because renting IS the highest & best use of that land. The ceiling caps it there. There's no higher use waiting to move in, so there's nothing to appreciate into — & your own number proves it. High fifth at minus 1.1, low fifth at plus 1.8. That's not a yield trap. That's the land telling you its ceiling. You're arguing something theoretical. I'm telling you the reality on the ground.

Here's the other half of the reality. The 1% rule is the worst metric ever invented to decide what to buy. It's a back-of-napkin filter that tells you nothing about the structure, the land, the tenant base, or what the thing actually costs to run — & it's the exact tool the turnkey & wholesale crowd uses to make bad deals look like math. A number hitting 1% tells you the price is low. It does not tell you the deal is good.

So what are you actually buying? A depreciating improvement sitting on capped land, & a gross yield that isn't yield. 8.8 percent gross on an old structure in a low-value area gets eaten alive — turnover, delinquency, vacancy, & capex on a house built before your grandfather. The premium that "survives" in the sheet is gone by the time you net it. Gross yield is a story. Net is the number, & nobody posts the net. I spent years appraising before I ever managed a door, so I've valued these exact structures — the forced-value ceiling on that vintage of house in those zips is real & it does not move because your spreadsheet wants it to.

And here's what that looks like in my inbox. Most owners of these high-yield houses eventually ask me to become the bank — to front them the money for repairs — because the property isn't actually cash flowing. That's the tell. If the yield were real, the house would fund its own roof. It doesn't. That's the single biggest reason I won't manage those properties. I only invest in my own backyard & I don't manage what I wouldn't buy. If I wouldn't manage it, I don't think you should own it — & I wouldn't manage most of what your high-yield fifth is pointing you at.

When those deals do pencil, they pencil on leverage. You buy cheap, you lever it up, & the return shows up because the debt is doing the work — not because the asset gained value. That feels like appreciation. It isn't. You're not appreciating. You're chasing more debt against a basis that structurally can't rise. The day something breaks — & on that vintage of house it will — the debt is still there & the appreciation was never real.

Your spread rule is a real observation, I'll give you that. But it's describing the shape of the land ceiling, not a place to put money. Wide spread just means the cheap dirt is very cheap. That's not opportunity. That's the market pricing a ceiling.

Would the house you're buying for that yield still be standing in 40 years without you feeding it? If the answer is no, you didn't buy an appreciating asset. You bought a liability with a rent check stapled to it.

Ken M. · Answer

Well thought through response, and what I would add is that when you sell the property (if you get "tired landlord" syndrome or to use the cash for other things, or if you don't handle estate planning correctly, you have real agent fees, closing costs, you have taxes due, depreciation recapture and as noted likely repairs to make to get it to an MLS level.

All of that is outside of factoring in a deteriorating/improving neighborhood or city, housing market economic conditions when you sell and an occasional black swan event. Investing is for the well guided investor.

Travis Timmons · Answer

@David Walters when the data and the anecdote disagree, trust the anecdote.

The more experience I get doing this (now about 15 years in and financially independent), the more I'd rather take the advice of my grandfather than trust a spreadsheet. Buy properties in places where people with options want to live. And when you rent to C-D-F tenants, they tear up the property. Even if they pay rent in full and on time, turnover expenses will eat up years of "cashflow" without even touching upon major capex items like roof, HVAC, etc.

@Jason Cory is out here doing the lord's work. He took you to school and you posted a long "but here's why I'm right" post.

Crystal Smith · Answer

Love the question so I asked my nerd partner to check it against zip codes in Chicago.  I won't go into how he checked the premise- just the results:  26 zip codes evaluate & the premise that cheap houses appreciate slower than expensive houses was empirically validated; but.... the conclusion that this appreciation lag entirely consumes the cash flow premium—rendering the cheap house a "trap"—does not appear to be true in Chicago.  in general the gross yield spread from cash flow exceeds 10% which means the cash flow generated by lower-tier assets easily absorbs the drag of stagnant appreciation.  He's a nerd and loves this stuff.

Jim Johnson · Answer

That's an interesting way to look at it, and I think it reinforces that cash flow and appreciation shouldn't be viewed in isolation.

In my experience, I'd rather own a property where the investment still works if appreciation is modest. Cash flow gives you options—it helps cover vacancies, unexpected repairs, and changing market conditions.

I also think the holding period matters. Over a longer horizon, strong cash flow that's consistently reinvested can offset a lot of the appreciation gap, especially if the property is easy to operate and keeps attracting reliable tenants.

The other piece I'd consider is risk. A lower-cost market with steady cash flow may produce a smoother ride than a higher-cost market that's relying heavily on appreciation to justify the investment.

Ultimately, I'd be looking at total return, but I'd still want the property to stand on its own based on today's numbers. If the deal only works because I'm expecting appreciation, that's usually a sign I'd dig deeper before moving forward.

Jonas Dannenmaier · Answer

Stuart nailed the mechanism. The way to actually test it on a given deal is to stop comparing headline cash flow and normalize both properties for real reserves first. Put a true capex line on each, meaning roof, HVAC, turns, not the fifty a month placeholder, age adjusted, plus a management line even if you self manage, then recompute. The cheap house premium usually shrinks or inverts the moment those two lines are honest, because the low cost property carries more deferred liability per dollar of rent. Then keep appreciation in its own column instead of blending it in, because one is cash you can spend and the other is equity you can only reach by selling or refinancing. Seen side by side per year over a five to ten year hold, the better door is usually the one that survives a bad year, not the one with the fatter month one spreadsheet.

Drew Sygit · Answer

Great conversation!

Jason Cory · Answer

@David Walters

There isn't a rule of thumb for land to improvement ratio

You're missing something that maybe I didn't explain properly or at all.

The appreciation in Ensley is the rent amount not the resale value. That's the ceiling I was referring to in my previous post.

As far as land value, it's essentially worthless in high yield areas. There isn't demand to build/improve.

I had a house burn years ago in Ensley. I took the insurance payout, demolished the house, & let the state buy the taxes.

You have to approach high yield in somewhat of an inverse condemnation scenario due to the area & all of its glorious amenities. Pew pew for example.

Without a rent check, you essentially have no value. Without value, you have no yield or investment. You have debt.

Dan H. · Answer

1 year is far too short a duration to perform any significant determination.

The tightest coupling in most markets on rent growth is appreciation.    To look at initial cash flow and appreciation without rent growth (with its strong correlation to appreciation) is leaving out a data point that on a long hold is far more critical than initial cash flow.

Math tells us that the higher rent growth market will always eventually produce better cash flow than the lower rent growth market regardless of the initial cash flow,

Good luck

Does the cheap-house cash flow premium survive once you net in appreciation?

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