Quick question about cash flow and appreciation.

50 Replies

Hello guys.

This site has been very helpful for me and encouraged me to start as an investor.

Again, thank you for responses and I am looking forward to get some again.

Typically, the more urbanized cities have lesser cap rate, and people are purchasing properties based on appreciation. For example, 1 room condo at the heart of boston costs around 400k and is being rented $2000 per month. If you consider all the fees (including mortgage payment), it will produce negative cash flow. However, property prices are going up for some reason.

I am really confused why this is happening. We know this type of properties already produce negative cash flow, and it seems like the rent is not going to increase tremendously. But, people are purchasing based on appreciation even though those buildings produce negative cash flow. How these types of buildings can be turned into producing positive cash flow in the future when numbers are really hopeless? Why people (including investors) are purchasing those buildings for what reason?

Any inputs will be appreciated. This can help me decide which field I should be concentrating more.

Thank you.

@Chang Maeng

I think what you are overlooking is retail buyers... people who are paying $400K for that condo and living in it. Obviously at those price/rent ratios, it doesn't make sense to pursue as an investment.

I was thinking about that. However, I figured out that some people are purchasing for investment purpose. I am sure there are other things that they think these buildings have value even though they dont produce any income.

Do you think are they buying for appreciation only? I am excluding those who are buying for residential uses.

@Chang Maeng

I guess I would ask are they currently purchasing as investments or did they pick them up a few years ago when the market was very depressed . If they're still purchasing, obviously they are counting on appreciation and/or aren't educated/comfortable enough with other options. If I lived in Boston and had $400K cash and was very worried the stock market is going to take a dive (which is certainly a possibility) and wasn't aware/willing to look at other markets that would cash flow better, then maybe paying cash for one of these units knowing I would probably make a small return and my investment should at least track along with inflation (and probably better) than it's a much better place to put that money than the bank.

If people are currently buying at those prices and using debt service, I've got no explanation.

You are exactly right.

I was talking about people who are currently purchasing as investment. They usually buy with cash or larger down payment. I was thinking maybe there are other factors that affect investors decision to purchase those type of properties.

Based on your answer, I kind of got an answer. Thank you.

Hi Chang Maeng,

The question you ask is the question I get asked by lots of investors because many of them can't understand why I would invest in properties only returning 3-5% rental returns. Personally, the way I look at it is like this.

Assuming the current properties I am invested in are just like what you are asking about. Turning rental returns 3-5% in a city with high population and high upward job mobility (in my case, mine are near beach, limited land, high demand due to weather and environment). Factor in a capital appreciation of say conservatively 8% per annum to give a total of say 13% returns per annum over say a holding of 5 years.

Now compared to places like Arizona or Atlanta, this might seem like very low yield when people are getting 15-20% yield, but what do I get in return? My thoughts are that in exchange for yield I get liquidity because the property is almost always easy to sell. Low risk because demand is constantly high due to strong factors like weather versus say dependance on one industry that could pack up and leave town suddenly. The capital gains generally tends to be higher in more desirable areas, especially where land is limited.

So as an investment, a low yielding piece of real estate dis not always completely irrational as an investment and personally, I am a strong believer that in todays market with so much information at our finger tips, prices and percentage returns and yields tend to be a good reflection of risk.

Just my opinion base don my investment style. BTW, I think Brookline MA is a great place to live.

I thought this blog post also made a good point regarding location versus yield and why sometimes a lower yield might make sense,

http://www.biggerpockets.com/renewsblog/2014/04/04/real-estate-principles/

CK HWANG.

Thank you for input.

I agree with you that buildings that are at prime area rarely drop in value, buy they do not appreciate that quickly either.

For example, "Factor in a capital appreciation of say conservatively 8% per annum to give a total of say 13% returns per annum over say a holding of 5 years." is not actually true. You can check appreciation rate at prime location vs less prime location.

If you search real estate cycles, you will see property prices have been risen throughout years, but more STEADLY.

For sure, there are other benefits of purchasing these propertie: easy to re-sell, lower vacancy rates, and etc.

What my concern is are those benefits worth even if its producing negative cashflow.

I think this phenomenon is causing because many people are delusional about outlook of these properties. I am not sure still because its really sophisticated. I just want to hear what others think about this subject.


Hi, this is my 2 cents.

Some investors may

1) going after depreciation more than yield.

2) buy & hold for LAND value.

3) control of ownership on that area for future developement

Updated about 4 years ago

@ANISH TOLIA, thank u for pointing out the mistake. @ANNUNCIATA R., Thank you. I meant to write: going after appreciation than yield

It doesnt make sense for depreciation. For most of the high cost areas, the value is in the land which you cannot depreciate. You can only depreciate the structure. So my home in the Bay Area may be worth $700K but the structure is only $200K at most so thats all you can depreciate. Homes in high cost areas appreciate because people want to live in them. Not rent them.

Im sure he meant

1) going after appreciation more than yield

I am wary of jumping on the appreciation bandwagon. However, I am noticing that there is a dearth of housing in South Bay. With a lot of monopoly money created by techs,the inbound cash from overseas buyers, and limited inventory, there seems to be no end to the demand. I guess that is what causes some investors to take higher risk and move away from fundamentals. IMHO.

Pardon my laziness but I'm just going to c&p what I wrote on a very similar thread:

Generally, investing on the West Coast (especially CA) and other more expensive areas like NYC, Boston, etc. is very different from investing in fly over states. Most of the people giving advise above are not familiar with your market. Matter of fact, what normally works for them (cashflow focus) is counterintuitive in places like Orange County.

I think you your investment is a winner, and your perspective spot on! You brought at a good time, you have a good property in a very solid market, and it covers cashflow. You're making good money from loan pay down, and already gained substantial appreciation. It's wise to scale back future appreciation expectations, as you had a big bump the last 3 years.

I strongly disagree with those who state that appreciation means nothing until you sell, or that it can vanish at any moment. 1- an appreciated property will allow you to borrow against it, to pull cash out for another investment. 2- you brought at the bottom of a serious recession, and up already 30%. It's gonna be a cold day in hell if that condo goes back down by 30%.

You also have an investment that is a cinch to manage- fixed up, professional tenants, an expensive location. Try comparing that with 10 houses in a middling hood, with lower incomes, more wear and tear and 10x factor of things that can go wrong!

I could go on. But suffice to say that my market, San Francisco, is even more expensive and crazier than So Cal! We have rent control, nutty pro tenant/anti growth politicians, and even worse cash flow. Have you heard about the protests against the tech, or Google commuter busses here? It made national news- only in SF would (some vocal) people be against tech companies providing free shuttles to their SF based employees. It all leads to an extremely restricted housing supply and hence RE inventory is almost zero. So why are well healed investors tripping all over themselves making multiple offers on seemingly any available property? Because they became very wealthy investing here!

Originally posted by @Anish Tolia :
It doesnt make sense for depreciation. For most of the high cost areas, the value is in the land which you cannot depreciate. You can only depreciate the structure. So my home in the Bay Area may be worth $700K but the structure is only $200K at most so thats all you can depreciate. Homes in high cost areas appreciate because people want to live in them. Not rent them.

This is an old wives tale. You are paying too much in taxes. Check the actual land costs in your area. You'll probably be surprised to see that the land value is closer to 30-40%. This is based on actually determining land value in the Bay Area for people that thought the same as you.

People don't buy $500,000 lots to build $200,000 homes. If a neighborhood is changing and tear downs are common THEN you might be in a situation where the land is worth more that the improvements but NOT more than the NEW improvements.

@CK Hwang , Thanks for sharing and posting your strategy. Good to hear someone is investing in Southern California and happy with it. Mostly hear on this site that one should be looking out of state.

@Bob Bowling

The average cost of new construction in my Zip code is $130 per square foot. My home is 1500 sq ft which puta the cost of NEW home at $200k. Most homes around me were built in the 70s and currently sell for over 700k. So actually people do buy 500k lots for 200k homes in high cost urban areas. The ratio is even higher in Sf or NY city.

Originally posted by @Anish Tolia :
@Bob Bowling

The average cost of new construction in my Zip code is $130 per square foot. My home is 1500 sq ft which puta the cost of NEW home at $200k. Most homes around me were built in the 70s and currently sell for over 700k. So actually people do buy 500k lots for 200k homes in high cost urban areas. The ratio is even higher in Sf or NY city.

Yeah, that's not how you would compute land value. Show me a $500, 000 res lot in your NBHD. Also costs do not equal value although I'd love to see a builder that will build on my lot for $130 sf. I did a study on SF costs. Builders wouldn't even break ground if they were not getting $250sf in entrepreneurial profit. That's on top of their profits as contractor. I'd hate to see what someone is providing at $130sf. Hell, Home Depot sheds run half that just for materials.

Originally posted by @Bob Bowling:
Originally posted by @Anish Tolia :
@Bob Bowling
The average cost of new construction in my Zip code is $130 per square foot. My home is 1500 sq ft which puta the cost of NEW home at $200k. Most homes around me were built in the 70s and currently sell for over 700k. So actually people do buy 500k lots for 200k homes in high cost urban areas. The ratio is even higher in Sf or NY city.

Yeah, that's not how you would compute land value. Show me a $500, 000 res lot in your NBHD. Also costs do not equal value although I'd love to see a builder that will build on my lot for $130 sf. I did a study on SF costs. Builders wouldn't even break ground if they were not getting $250sf in entrepreneurial profit. That's on top of their profits as contractor. I'd hate to see what someone is providing at $130sf. Hell, Home Depot sheds run half that just for materials.

So, how much profit construction company is taking if it had a contract for $250 per square feet vs $130 per square feet? If its still taking $130 per square feet, doesn't it mean it still earns profit? How its cost can be so much different? Or are you talking about different construction type?

@Bob Bowling I'm sure your materials costs are much higher in Hawaii. Also, the cost for environmental mitigation probably is worse than California, you have volcanoes!

the reason cap rates are so low in new York and other major urban centers imo is because of vacancy and security. Meaning if cities in the United states were to start to go under then New York would likely be the last to do so. Therefore New York is considered to have low risk so lower returns. Some people also just like the idea of owning real estate in these places. It has a certain status appeal. It is blue chip.

They are solely playing the appreciation game Chang. Their 'cash flow' will come at the time they sell it for a higher price than what they paid. If you want steady monthly cash flow, as rentals are normally known for, you won't get it with those types of properties. There are plenty of other types that you will though, and they can still be nice and can often stand to gain a good bit of appreciation as well. Likely not as much as the markets you are referring to, if even in the same ballpark, but it's just different games to play in the REI biz.

Originally posted by @Chang Maeng :
Originally posted by @Bob Bowling:
Originally posted by @Anish Tolia :
@Bob Bowling
The average cost of new construction in my Zip code is $130 per square foot. My home is 1500 sq ft which puta the cost of NEW home at $200k. Most homes around me were built in the 70s and currently sell for over 700k. So actually people do buy 500k lots for 200k homes in high cost urban areas. The ratio is even higher in Sf or NY city.

Yeah, that's not how you would compute land value. Show me a $500, 000 res lot in your NBHD. Also costs do not equal value although I'd love to see a builder that will build on my lot for $130 sf. I did a study on SF costs. Builders wouldn't even break ground if they were not getting $250sf in entrepreneurial profit. That's on top of their profits as contractor. I'd hate to see what someone is providing at $130sf. Hell, Home Depot sheds run half that just for materials.

So, how much profit construction company is taking if it had a contract for $250 per square feet vs $130 per square feet? If its still taking $130 per square feet, doesn't it mean it still earns profit? How its cost can be so much different? Or are you talking about different construction type?

Updated about 4 years ago

When I did my study in about 2006 basic condo/mullti-family new construction was selling at $600 sf. Land costs were basically $60-100sf. Reported cost (hard and soft) by builders were in the $200+ sf. That left about $300 sf for holding (5-9%) and se

Updated about 4 years ago

and selling costs (4%) and a large entrepreneurial PROFIT which is assessable under CA Revenue and Taxation code. I surprised a lot of educated and experienced people that wanted to believe that the developers/builders were making 8-20% profit total.

Originally posted by @Karen Margrave :
@Bob Bowling I'm sure your materials costs are much higher in Hawaii. Also, the cost for environmental mitigation probably is worse than California, you have volcanoes!

I do live on the slope of a volcano. And my 2008 purchase was over $1,000 sf and my bath remodel (only sink moved and new spot backed up to the kitchen sink) added another $463 sf for the bathroom area! Yikes! Wait, my volcano has been inactive 150,000 years.

Originally posted by @Ali Boone :
They are solely playing the appreciation game Chang. Their 'cash flow' will come at the time they sell it for a higher price than what they paid. If you want steady monthly cash flow, as rentals are normally known for, you won't get it with those types of properties. There are plenty of other types that you will though, and they can still be nice and can often stand to gain a good bit of appreciation as well. Likely not as much as the markets you are referring to, if even in the same ballpark, but it's just different games to play in the REI biz.

Yea. That is what I have figured out. What I am trying to do is to find properties that are located at medium-high end place and have positive cash flow like you mentioned above. It will be my homework to figure out where these properties are located at.

Originally posted by @Ali Boone :
They are solely playing the appreciation game Chang. Their 'cash flow' will come at the time they sell it for a higher price than what they paid. If you want steady monthly cash flow, as rentals are normally known for, you won't get it with those types of properties. There are plenty of other types that you will though, and they can still be nice and can often stand to gain a good bit of appreciation as well. Likely not as much as the markets you are referring to, if even in the same ballpark, but it's just different games to play in the REI biz.


Ali, you seem to totally misunderstand investing in high appreciation areas. Do you know of any area where rents stay stagnant over time while prices increase dramatically? Rent growth and appreciation go hand in hand. My 9-11% appreciation comes with rent growth of 6-7%. So when my property doubles in value every 10 years I can take out a couple of hundred of thousand in equity and pay it off with the now positive cash flow.

Even with steady cash flow in Podunk how much can you pull out in say 10 years time of little to no appreciation? If you want to make this a game at least make it a math game and see what your total profitability is over your holding period. I invest for APPRECIATION and RENT GROWTH. They generally come as a package. It's like you buying an uninhabitable house. You can't make any money until you invest more.

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.