Cash Flow or Appreciation: Which Are You Choosing Right Now?

Question

I'm curious how other investors are looking at today's market.

Would you rather buy a deal with thinner cash flow in an area you believe has strong appreciation potential, or wait for a property that produces better cash flow from day one?

I've seen investors make money both ways.

Some are willing to sacrifice a little cash flow because they believe appreciation, rent growth, and principal paydown will create bigger returns over time.

Others won't touch a deal unless the numbers work immediately.

What are you prioritizing right now, and what's driving that decision?

Jules Aton · Answer

I have always prioritized a good rental in excellent neighborhood which tends to skew toward less cash flow but have been easy to sell and witih solid appreciation. Aggravation level is often reduced also with higher end neighborhoods. The change I have made for current climate is paying cash on last two deals due to rates.

Dan H. · Answer

I am all about best return.   The reality is the best return is achieved with the highest appreciation.  The highest appreciation market will have the best cash flow over a long hold.

1) There is poor correlation between initial cash flow and actual long term cash flow. The reason for this is that RE market prices are based on numerous criteria. Some of the big ones are expected appreciation, expected rent growth, and risks. In most markets, the market with the highest rent to price ratio is the lowest class areas. This is because of the risks and effort to have rentals in that market. Similarly, the markets with the best initial cash flow typically have poor historical appreciation and rent growth. The properties with poor initial cash flow often have good/great historical appreciation. Rent growth has a strong relationship to appreciation. The better appreciating property is likely to have the better cash flow over a long hold.

2) cash flow is taxed annually. Appreciation gets taxed at property sale and there are legal means to avoid paying the taxes upon selling. RE investors often are in high tax brackets and those that are not strive to get into high tax brackets. My goal is to obtain return while minimizing taxes. If I have to pay taxes of 40% on cash flow but nothing on the appreciation (even extracted appreciation), then the cash flow only provides 60% value compared to the value achieved from appreciation. Appreciation accomplishes paying less taxes much better than cash flow.

3) Some people act as though cash flow is guaranteed. At the Great Recession (GR), there were many markets that suffered increased vacancy and reduction in rents. Detroit, Las Vegas, much of Arizona, etc had actual cash flow reduced due to the GR. In contrast there are many cities that have not had a single 10 year period since the numbers were tracked without appreciation (my market is one such market). Appreciation may not be guaranteed, but it has yet to not happen for a 10 year span in my market.

One of my recent RE purchases was the most negative cash flow non-commercial property that I have ever heard of. Purchase $2.3m, fully occupied rent of $6k/month. Today the value is up $1m above purchase and rehab costs. I expect rents to exceed $25k/month this year. My PITI is $9476. From huge cash negative to pretty good cash flow. Total return has been outstanding.

Now for the $1m of gain, I can extract some of this appreciation and not pay taxes until I sell the property.  I can 1031 exchange to put off the taxes at time of sale.   If I die the properties get a step up basis and the taxes on the gain is forgiven.

As to the deal structure, best return, and RE's super power, is via leverage. I have yet to see a thorough underwriting that justifies a lower LTV to buy cash flow.

as for rent model, buy high class RE in extremely desirable locations and rent them as STRs.   They are not making more beaches.   Lakes can be made, but it is not easy.   Major rivers, lovely mountains.  Private access to a beach, is there any realistic scenario that private beach access will not gain value in the long term?

Or you can choose to buy that cheap Midwest property that cash flows a few hundred a month and has historical rent growth and appreciation below the inflation rate.  If you concentrate on paper cash flow (versus actual cash flow), the best properties will be in lower class areas. See how that is working for you a decade.

Good luck

Denise Supplee · Answer

Great question.

I've seen investors succeed with both approaches over the years, but personally, I've always preferred deals that make sense from day one. That doesn't mean appreciation isn't important. It's certainly a nice bonus. But I've found it can be difficult to predict, while cash flow is something you can evaluate more directly.

As a long-time Realtor, property manager, and investor, I've learned that strong fundamentals tend to hold up well across different market cycles.

Vernomie Willson · Answer

Cash flow right now for me. Appreciation is just guessing. Nobody knows what prices will do next year or five years from now. But cash flow every month is real money in my pocket. I would rather sleep well knowing the bills are covered.

Nick Sansivero · Answer

Both, always. I'd never buy in a market if I wasn't convinced it would see continued growth, or a property that didn't cash flow.

Alex Olson · Answer

Cash flow and appreciation can happen in many parts of KC. Of course buying right helps. Turnkey or value add can both have cash flow now but cash flow comes later do to great rent growth we have here in Kansas City.

Kerlous Tadres · Answer

Right now I'm prioritizing cash flow because in this rate environment, a deal that doesn't work on day one leaves you too dependent on things you can't control. Appreciation is real, but it's never guaranteed, and I've seen too many investors get stuck holding a property that bleeds monthly while they wait for a market that takes longer than expected to move.

Joe Villeneuve · Answer

Both.  Why do you have to choose?  You defeat the idea of REI when you do.  Basing a buy decision on one or the other just places the one you don't choose in an adversarial position of the other.

If you think you have to choose one or the other, what that tells me is you don't understand the role of each in REI, and why it is important...mandatory, to have both.

Kenneth Garrett · Answer

@Frank Ransom

I’ve always bought in decent neighborhoods and it needs to cash flow.  Cash flow takes care of your bills as well as CapEx, Maintenance, vacancy, etc.  I treat appreciation as a bonus.  It can be a big bonus.  Even during this unstable economy things are still appreciating depending on your market albeit at a slower rate or almost flat.

In my opinion, when the stability of the economy gets to a point where we have growth again, we will see a big boom for appreciation and rents will move up again.  How long that will take no one knows.  This is why finding solid deals even during economic turmoil is what can create real wealth.

Cash Flow or Appreciation: Which Are You Choosing Right Now?

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