Investor · Dallas, TX · Member since 2016 · 887 posts · 1k+ votes
While cash flow is great and I strive to cash flow as much as I can, in the long run could this strategy be less profitable than buying & holding in a market that will see high levels of appreciation?
I hear folks talk about investing in the mid-west in high cash flowing areas, but in general (don't look at the last 2 years), these properties appreciate very poorly compared to "high appreciation" areas.
I'm curious if any investors have a high cash flowing property in a low appreciation area that they purchased +/- 30 years ago as well as a no/low cash flowing property that they purchased in a high appreciating market such as Coastal CA, Orange County, San Francisco, Coronado Island San Diego, Lower Manhattan, Miami beach, etc., that was purchased around the same time.
I'd be interested to see an analysis at the end of, let's say 30 years later to see when the dust settled which property made more money. Assuming that both properties were purchased at approximately the same time and sold roughly 30-years later. I know there are a ton of variables, but could it be possible that the obsession for cash flow is instant gratification and will actually profit less than a high appreciation property in the long run?
Also, I'm not arguing against cash flow or saying that people shouldn't be focusing on it. This question is very specific to a long-term analysis.
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
4y
How can cash flow be overrated if the goal is to make money? Last time I checked, cash was still money. If you don't have cash flow, you have negative cash flow, which means you are adding to your cost.
Also, collecting equity in the same property is actually losing money.
Bottom line is this, negative cash flow costs you money, and equity build up in the same property (as in the closer that property gets to 100% equity) is in fact losing money...not making it. So, the combination of the two, is deadly...and bad math.
Rental Property Investor · Chicago and mainly invests in KS remotely · Member since 2018 · 360 posts · 314 votes
4y
This is actually a more complicated answer. Here's why:
As you grow your real estate portfolio, you no longer qualify based on your own DTI, instead on DSCR which based on the asset's own performance (local banks may differ slightly from DSCR private money; local banks are more like common sense lenders and may ask for your personal financial statements as well). Well, if you don't have cash flow, you won't be able to pull out max funds on a refi, which means you're leaving more money in the deal, and growing your portfolio slower. In a high cash flow market, you can take out max funds on refi, and grow your portfolio faster. In addition, in high cash flow markets, you might find deals easier because people care less about the price of their home or they just mess up their life more often.
To give an example, say you buy a place in Austin for 450K and rent it out for 2750 a month, there is no way that a DSCR lender will let you take out 75-80% LTV on a refi. But if I purchase a place in Wichita KS for 100K I can rent it out for 1000 a month, I can take out 80% LTV on a refi with my local bank. Now do this over and over again for many years, I can grow my portfolio size at a faster rate than if I had invested in Austin. If the high appreciation market appreciates twice as much as high cash flow market, but you can grow the dollar value of your portfolio twice as fast in high cash flow market, then your dollar return attributed to appreciation is the same, but you would end up with higher cash flow in high cash flow market and about equal appreciation dollar, so high appreciation market is an illusion for BRRRR and could be detrimental. So in sum, cash flow and appreciation are a balance, tilting in favor of high cash flow markets.
Not sure if you understood the point of the post. I'm asking if anyone has real-life data so we can evaluate these scenarios.
Let's say back in 1990 someone were to purchase a a 4-plex in the mid-west for 200k. This same investor bought a cottage on the coast, let's say La Jolla San Diego for 200k as well. In this scenario let's assume that the 4-plex generated 700k cash flow over the life of the loan. Let's say that the beach house didn't make anything for the first 5 years of the loan and made modest cash flow from year 6 forward, totaling in 200k positive cash flow throughout the life of the loan.
At this point you can conclude that the 4-plex made 500k more than the beach house over the life of the loan through cash flow. Let's say that we go to sell and the 4-plex is worth 800k and the beach house is worth 1.7 million.
Another wrinkle: cash flow dollars from 30 years ago are worth 211% more than today, with the scale declining over time. So even using the hypothetical 1.5 million gain, the tax hit and opportunity cost over that time might easily negate any perceived advantage
@JD Martin not sure I understand you… analysis should be the other way around. The cash flow will depreciate with inflation unless we have this sort of massive appreciating rental market — not very common. Meanwhile, a “well cash flowing” will still be taxed somewhat year over year (depending on the property’s financials and depreciation) . A capital gains are gnerallly taxed lower and only when you sell. If you 1031 that appreciated property into an income generating property for retirement, then you have all the wealth to generate income. Up to that time, no income tax…
Sorry, I don't think I explained what I was saying very well.
Cash flow (in theory) should *not* depreciate with inflation because rent should mirror inflation. So a 1990 dollar should be a 2020 dollar. I realize a lot of landlords don't follow this process but virtually all other industries do and there's no rational reason why it shouldn't be the case.
So if cash flow follows inflation, you return holds steady over time. And because your cash flow is parceled out over years, your tax bill is lower (or nonexistent, depending on your personal financial situation) as you go. Further, let's assume apples to apples and neither party needs the money to pay for their own support (since that's impossible in the non-cash flow property in SD). The individual with steady cash flow gets to reinvest those returns as they go. As for 1031 exchange, well sure you can do that but ultimately unless you take a mortgage or pay the tax bill you never get to use that money.
All of this is somewhat useless without having some kind of numbers to look at. In the OP's fantasy figures, property 1 purchased for 200k generated 700k and is worth 800k at the end, property 2 purchased for 200k generated 200k and is worth 1.7 million at the end. If you just use simple math, Property #2 is the winner, right? 1.7mil plus 200k minus 200k = 1.7 mil profit, property 1 800k plus 700k minus 200k = 1.3 mil profit
But if we assume as the OP did that property #2 generated nothing until the end, and that property one generated steady inflation dollars, then you find that Property one generated $23.3k per year, but year 1 is really $49.3k (inflation), year 2 is $48k, etc. so you can add another 300-350k to property #1 which brings it to $1.6-1.7 mil. About equal to property #2.
Except that Property #1 also probably paid little to no taxes after depreciation and operating expenses. Still, if we assume that each property had the same tax implications over the 30 years and the end value is the end value, Property #2 still pays $255k in capital gains while Property #1 pays $90k in capital gains. So you can add another $150k to property #1.
Now assume Property #1 knows how to manage that 4 plex (after all, they made $700k in 30 years plus it went up in value, right?) so they take those proceeds and their cash flow to buy another 4 plex every 2 years, with 20% down. In 30 years they own 15 4-plexes all bringing in $23k, or $345k per year, and they've enjoyed the same rate of appreciation meaning they own 15 buildings with free equity of anywhere between $500k and $100k each - let's average it to $300k each. That's $4.5 million right there alone.
Obviously this is all just for fun. No one can actually answer this question without real-life examples so it's fairly impossible, but one thing is for certain to me: the owner of Property #1 actively invested and created their fortune, while the owner of Property #2 hoped for a fortune because short of a hunch 30 years ago, they did nothing more than ride a market they hoped was prime for appreciation. It might seem obvious to us today that a coastal house in California was going to be worth a fortune, but if you observed pricing in those areas of California from the 50's through the 80's it would look nothing like what's happened in the last 30.
While cash flow is great and I strive to cash flow as much as I can, in the long run could this strategy be less profitable than buying & holding in a market that will see high levels of appreciation?
I hear folks talk about investing in the mid-west in high cash flowing areas, but in general (don't look at the last 2 years), these properties appreciate very poorly compared to "high appreciation" areas.
I'm curious if any investors have a high cash flowing property in a low appreciation area that they purchased +/- 30 years ago as well as a no/low cash flowing property that they purchased in a high appreciating market such as Coastal CA, Orange County, San Francisco, Coronado Island San Diego, Lower Manhattan, Miami beach, etc., that was purchased around the same time.
I'd be interested to see an analysis at the end of, let's say 30 years later to see when the dust settled which property made more money. Assuming that both properties were purchased at approximately the same time and sold roughly 30-years later. I know there are a ton of variables, but could it be possible that the obsession for cash flow is instant gratification and will actually profit less than a high appreciation property in the long run?
Also, I'm not arguing against cash flow or saying that people shouldn't be focusing on it. This question is very specific to a long-term analysis.
If you can tell me what appreciation rate will be in the furture, what interest rates will be, what inflation rates will be, how much property taxes will be and how much capital gains rate will be going up, any new taxes the government can dream up, how the government will address $200,000,000,000,000 in unfunded liabilities they have run up and where the pandemics will be, I can provide you with the answer to your question. ;-)
Oh, I see what you are saying. I don't entirely agree... But, do agree that unless you have real situations and more detailed analyis with tax consequences (e.g. prop2 should have all the depreciation value effectively as PAL if the rent covered the expenses...) its tough to really determine.
Did you do your inflation technique (what is that, the forward cost of money or something) for prop2 since example has $8k? I still think that cash is going to get taxed, unless you within the "depreciation window" in which case prop2 still has more built up reserve PAL to reduce tax burden when property is sold.
There is a lot that goes into this.. I've lost track of which thread this is as we seem to have a few of these going on simultaneously... But, ALL the various investing strategies that come up have their place, and its a matter of using them for the appropriate deal and/or market. I think that gets lost in all the "sales pitch" of everything that goes on. I don't think I've actually seen it where they describe what sort of situations the strategy applies, they just "educate" or "sell" you on an approach... Yeah, I've been getting kinda bummed on all this...
Oh, I see what you are saying. I don't entirely agree... But, do agree that unless you have real situations and more detailed analyis with tax consequences (e.g. prop2 should have all the depreciation value effectively as PAL if the rent covered the expenses...) its tough to really determine.
Did you do your inflation technique (what is that, the forward cost of money or something) for prop2 since example has $8k? I still think that cash is going to get taxed, unless you within the "depreciation window" in which case prop2 still has more built up reserve PAL to reduce tax burden when property is sold.
There is a lot that goes into this.. I've lost track of which thread this is as we seem to have a few of these going on simultaneously... But, ALL the various investing strategies that come up have their place, and its a matter of using them for the appropriate deal and/or market. I think that gets lost in all the "sales pitch" of everything that goes on. I don't think I've actually seen it where they describe what sort of situations the strategy applies, they just "educate" or "sell" you on an approach... Yeah, I've been getting kinda bummed on all this...
Yeah, and that's just the thing - there's no good way of coming up with an answer on hypotheticals. People have become really rich on appreciation alone, and they've become really rich on cash flowing properties that had minimal levels of appreciation. The only thing I personally like about "cash flow" vs "appreciation" is that the latter relies on future projections and conditions while cash flow happens in the here and now. I don't have any control whatsoever on what happens in the future, but I can adjust and react to what's on the ground in front of me. Another wrinkle in the argument I never even addressed is that the appreciation investor could harvest the appreciation - assuming interest rates were low enough - as they went and redeploy that money into other assets, increasing their return.
Big picture, on average the higher yielding sfh areas have outperformed compared to the more expensive coastal cities. With that being said, the difference isn’t that much and of the top returning cities there’s a combo of both rental yield and appreciation. This is also not including things like value add deals and buying distressed, etc. You can get higher returns in either an appreciation or cash flow market with good management. Also not taken into the account is the absolute PITA it is to manage b and c class rentals from a distance.
@JD Martinagree totally.. especially about re-leveraging — so many tactics available in rei. It also works in reverse in my opinion, do a std refi (rates allowing) years down the road and now your property cash flows since your loan is smaller (albeit less leveraged). Even better is just recast the loan…. People get stuck on “today”
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
4y
Past performance does not guarantee future results. Affordability has collapsed in the last 6 months over interest rates, but not evenly across all regions.
The Midwest is the only region left in the US where median income is over the median home price. Combine that with 35% remote work it is very likely that future appreciation markets will be different than past. Plus fresh water, moderate summers and generally high quality of live is already changing migration behavior. That's among other reasons why I am bullish for Milwaukee.
The question of cash flow vs. appreciation has always been about balance. Cash flow keeps the lights on and is necessary to grow, appreciation is where wealth is generated. You can't really get wealthy on cash flow alone, I have seen investors who tried for 30 years and have gone nowhere. In the end you need a mix of both, cashflow and appreciation.
It's also much harder for markets where median homes cost 700k to double in value compared to 200k.
Real Estate Agent · Lowell, MA · Member since 2019 · 1k+ posts · 1k+ votes
4y
In my opinion you buy for cashflow you hold for appreciation. That’s what I think when we say we’re “buy & hold” investors. To your point $100 per door per month is great but the true wealth is made over 30 years where you have a paid off property with none, or very little, of your own money in it. Even if you sell it for what you bought it for you make out with that lump sum cash out more than you ever did on the cashflow. Then add in the fact that even in the lowest appreciation markets you’d expect inflation to run its course and you’ll be selling it for significantly more than you paid for it 30 years ago.
Real Estate Agent · Chicago, IL · Member since 2017 · 2k+ posts · 2k+ votes
4y
The bulk of the profit in real estate forsure comes from total return not cashflow but if the property doesn't atleast cashflow positive it can turn into a liability real fast. Unless you have a really high networth I would never recomend buying something without a safe margin of cashflow.
Investor · Campbell, CA · Member since 2016 · 78 posts · 33 votes
4y
@Greg R. I would normally agree but here are some things to think about. I live in the Bay Area, California which is a high income area. More and more I hear of relatively high income people leaving purely because affordability and value is a challenge. Additionally, these high appreciation markets also demand much higher salaries which employers don’t like. Employers are much more nimble nowadays in where they hire. I believe remote work will be predominant for white collar jobs in the future and if not that, you see it more and more common for employers hiring in 2nd/3rd tier markets for lower salaries. With these macro trends I think tier 1 traditionally high appreciation areas will be facing a headwind.
Investor · Campbell, CA · Member since 2016 · 78 posts · 33 votes
4y
@Joe Villeneuve can you please expand on what you mean when you say collecting equity in the same property is losing money? Do you mean to say that the opportunity cost of that equity hills up through cash flow equates to a loss?
While cash flow is great and I strive to cash flow as much as I can, in the long run could this strategy be less profitable than buying & holding in a market that will see high levels of appreciation?
I hear folks talk about investing in the mid-west in high cash flowing areas, but in general (don't look at the last 2 years), these properties appreciate very poorly compared to "high appreciation" areas.
I'm curious if any investors have a high cash flowing property in a low appreciation area that they purchased +/- 30 years ago as well as a no/low cash flowing property that they purchased in a high appreciating market such as Coastal CA, Orange County, San Francisco, Coronado Island San Diego, Lower Manhattan, Miami beach, etc., that was purchased around the same time.
I'd be interested to see an analysis at the end of, let's say 30 years later to see when the dust settled which property made more money. Assuming that both properties were purchased at approximately the same time and sold roughly 30-years later. I know there are a ton of variables, but could it be possible that the obsession for cash flow is instant gratification and will actually profit less than a high appreciation property in the long run?
Also, I'm not arguing against cash flow or saying that people shouldn't be focusing on it. This question is very specific to a long-term analysis.
heres one.. I bought 3 acres in Sonoma county CA in 1995 for 30k and let it sit paid taxs of 300 a year for all those years field mowed it about every 3 years or so when it got nasty.. so maybe another 15k into it. never made any cash flow never tried really sold in 2020 or just a tad over 2 mil. Only property i could have bought as a rental in 95 for 30k would have been a hood rat type property so lets say it made 400 a month for 25 years or 100k in net cash flow probably would have had to put at least 30k back into cap ex etc.. and value today maybe 80k maybe 100k so thats one example. But if you look at the west coast there is NO way any low end cash flow market in the country would have out performed anything from San Deigo to north of Seattle and most of the Eastern side of the Sierras and Cascades. And over time rents would have went from a little negative in the high priced markets to very nice positive over those same years.
Now lets look at the reality of the situation you have very few investors from the mid west or cash flow markets come looking to buy anything on the West coast given the price to enter barriers.. and lets face it as investors we simply have to invest / or play the cards that are dealt us. There are plenty of mid west investors who have done very very well over the years especially the ones who paid cash and started stacking up the inexpensive rental houses that you can find there.
@Joe Villeneuve can you please expand on what you mean when you say collecting equity in the same property is losing money? Do you mean to say that the opportunity cost of that equity hills up through cash flow equates to a loss?
Scenario: Property (assuming positive CF) Purchase Price $100k DP (20%) = $20k Initial Equity (paid for with DP): $20k Cost to REI: $20k Value of Equity: $100k (5 to 1)
After Purchase (leaving equity in property) Property Appreciates to $120k Equity increase to: $40k Value of Equity: $120k (3 to 1)...it went down
Selling Property (Moving equity to next property) Equity converted to Cash: $40k Value of Equity: $200k (5 to 1...again)...it went back up
The value of your equity isn't the face value of your equity...it's the buying power of it. When a property appreciates, the equity grows on a 1 to 1 ratio with it. When you buy the property, the initial equity (Down Pmt) buys a property at a 5 to 1 ratio. In the above example, the face value of the equity doubled, but the true value of the equity could/should have been Higher. The equity lost $80k in buying power. Don't fall in love with your property, REI isn't property collecting...it's money collecting. Specifically cash investing. Equity isn't cash, and it isn't yours...the property owns the equity, and you own the property. Not the same thing. The role of cash flow should be to recover your cost ASAP. Your cost is ONLY the cash that comes out of your pocket. This includes DP, negative CF, rehab, outside loans, added payments made towards the principle (this doesn't save you money...it costs you money), etc... The role of equity is to grow through appreciation, and to move when it doubles to the next investment. The role of the REI should be to manage all of this. Cash flow and equity are both forms of cash. Cash flow is real, and liquid. Equity frozen and isn't real until it's defrosted.
In my opinion you buy for cashflow you hold for appreciation. That’s what I think when we say we’re “buy & hold” investors. To your point $100 per door per month is great but the true wealth is made over 30 years where you have a paid off property with none, or very little, of your own money in it. Even if you sell it for what you bought it for you make out with that lump sum cash out more than you ever did on the cashflow. Then add in the fact that even in the lowest appreciation markets you’d expect inflation to run its course and you’ll be selling it for significantly more than you paid for it 30 years ago.
If you let a property get to 100% equity from appreciation, the property value will be much larger than the cash you put into it. However, you will have lost at least 10-20 times more than that. The longer your equity stays in the same property, the more money you lose.
Flipper/Rehabber · Colorado Springs, CO · Member since 2016 · 499 posts · 167 votes
4y
If they hold a property for 20-30 years and are depreciating every year, the cap gains will be thru the roof! I guess the appreciation can be used to cover huge cap gains taxes when property is sold? Or if they 1031 they will have the challenge of repeating the cash flow, so ... seems like a tough problem.
Not sure what you are saying… only improvements are depreciated based usually on the purchase price. Depreciation is taxed upon sale as depreciation unrecapture at 25%. Capital gains, more or less the appreciation above the cost basis / purchase price, is taxed at generally a lower rate than ordinary taxes. And you only get taxed on the profit/ gains…
Your “value of equity” to me looks more like leverage potential…. It doesn’t provide anymore value to you since the property in question is still leveraged and thus that 80% “value” is still held by the lien holder.
Appreciation is the “gain” above your cost basis. Are you really “losing” equity by having an appreciated property? Isn’t appreciation just “free” equity — almost like “inflation” working towards your benefit?
Your “value of equity” to me looks more like leverage potential…. It doesn’t provide anymore value to you since the property in question is still leveraged and thus that 80% “value” is still held by the lien holder.
Appreciation is the “gain” above your cost basis. Are you really “losing” equity by having an appreciated property? Isn’t appreciation just “free” equity — almost like “inflation” working towards your benefit?
I didn't say you were "losing" equity, I said you need to "move" it. What you are losing is the value of the equity because the ratio of equity to PV goes down as equity builds in the same property. Example: $100k property bought with $20k DP. The DP is you buying your initial equity. This means your equity is in a sense buying the property, and with a 20% DP, the equity is buying a property worth 5 times the equity. As the property appreciates, the equity grows $1 for every dollar of appreciation. That means it grows on a 1 to 1 ratio, not the same 1 to 5 ratio at the start, so this growth, although the number increases, the value of it based on the PV it represents is being diluted. Let's say the PV goes up from $100k to $120k, that would also mean the equity would increase from $20k to $40k. Sounds like you made money...and you did, but you lost more than you gained. Here's why. Your equity is now representing only a 1 to 3 ratio in PV. When the property is sold, you can go back to that 1 to 5 value...but the equity remains the same, you are just moving it. Now it represents a 20% DP again, and the PV is now $200k...not just $120k. You are about to say, "...but the equity doesn't increase", and you'd be correct...for now. The increase in equity from appreciation is based on the PV times that appreciation rate. So, would you have greater total equity if you applied a 5% appreciation rate to $120k (increase in PV and thus equity of $6k), or that same 5% appreciation rate applied to $200k (increase in PV and equity of $10k). Repeat this comparison a few more times, extending each option using the same appreciation rate for each (say 5%), and see how fast the appreciation grows. Now add to that, the increase in cash flow because you're buying larger and/or more properties. The power of compounding is a wonderfully powerful thing.
...and, the only "cost" to the REI is the cash they spend on the property. Total cost doesn't equal cost to the REI, unless you buy the property all cash.
Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 798 votes
4y
I think it depends on your perspective. Everyone wants cash flow and I would consider myself a cash flow investor. This means that value add, appreciation, net worth, and cap rates are an after thought.....but that's just me.
I would say that the the return on your equity is probably the most underrated calculation. In other words if you owned a property for a long time and have a significant amount of equity, could you trade up to a more valuable property if you sold that existing property and still have the cash flow you need. Or at least a delayed gratification of higher cash flow than your existing property. It's a math equation that we should all consider. Just like in Monopoly we want to turn that green house into the Red Hotel.
