The mindset of the Cash Flow investor: LA vs Baltimore

162 Replies

So I have to put $1,500,000 in a rental somewhere. The option (for whatever reason) is either LA (appreciation) or Baltimore (cash flow).

Sure, investors never can agree to disagree on which is best, but the numbers seem to suggest its not  necessarily an even contest.

Some facts:

We assume this is an all cash purchase... no leverage or debt (financing). The idea here being that the quality of an investment shouldn't be determined by how it is financed. Sure we can use debt and come up with 100o different scenarios but thats not the point here.

So...

.               Los Angeles                Baltimore
Initial Investment              $1,500,000              $1,500,000
# of Properties                       2                   12
Monthly Rent / Property                  $ 3,500              $ 1,395
Gross Rent / Year                 $ 84,112             $207,349
Gross Expense / year 45%                 $ 37,850             $ 93,307
Yearly CF                $ 46,262             $114,042
Monthly CF                  $ 3,855              $ 9,504
10 Year CF @ 3% rent growth                $530,338          $1,307,365
Cap Rate                  3.08%              7.60%

Apparently, $1.5 mil can (if you are lucky) get you 2 average SFRs in LA; same amount can also get you about 12 average SFRs in Baltimore. 

Monthly rent in LA = $3500 and in Baltimore = $1395.

Gross rental income per year for LA =$84,112 and Baltimore =$207,349.

Total Expense @ 45% for LA=$37,850 and Baltimore's=$93,307.

CF Per Year for LA = $46,262 and Baltimore's=$114,042

So approximately the LA properties generate a monthly CF of $3855 and Baltimore $9504

If we assume rent increases at 3% per year to keep pace with inflation, total CF in 10 years would equal: $530,338 for LA and $1,307,365 for Baltimore.

From a CF perspective it appears Baltimore wins.

But you say, LA appreciates faster in the long run -- true. Last 40 years for instance LA grew at an average of 7.3% per year and Baltimore at 4.8% per year. 

What does this mean?


,          Los Angeles               Baltimore
Invest. Value 10 Years           $3,034,509             $2,397,199
Appreciation           $1,534,509                $897,199
10 Year CF            $530,338             $1,307,365
CF + Appreciation          $2,064,848            $2,204,564

The initial $1.5 mil in both cities in 10 years (the holding period) would be worth $3.03 mil in LA and Baltimore $2.4 mil. So LA wins the appreciation game.

But what is the net effect of things? 

Adding cumulative monthly/yearly cash flow to appreciation, Baltimore's total = $2.204 mil and LA =$2.064 mil.

So is it always best to wait for appreciation? Apparently not. The cumulative effect of cash flow from some markets can be just as effective as appreciation.

Sure you can always access equity and try to reinvest -- the same is true for both markets though. 

To some investors, even if the long run appreciation exceeds cumulative CFs, the CF route may still be the best option (for them) if their primary objective is/was positive income/CF.

Oops! Rent increases follow a similar trend as price appreciation, so LA rent increases at a rate ~1.5x Baltimore's.

Oops! Rents and expenses don't scale linearly with rents ... 2 single family homes in LA will have ~16% the CapEx of 12 single family homes in Baltimore, regardless of rents and price points.

Oops! 2 tenants paying $3500/mo each will be much easier to manage and a much better tenant class than 12 Baltimore tenants at $1,395, resulting in much lower vacancy and steadier cash flow with fewer management headaches.

Oops! Long term LA wins the appreciation game AND the cash flow game.

Originally posted by @David Faulkner :

Oops! Rent increases follow a similar trend as price appreciation, so LA rent increases at a rate ~1.5x Baltimore's.

Oops! Rents and expenses don't scale linearly with rents ... 2 single family homes in LA will have ~16% the CapEx of 12 single family homes in Baltimore, regardless of rents and price points.

Oops! 2 tenants paying $3500/mo each will be much easier to manage and a much better tenant class than 12 Baltimore tenants at $1,395, resulting in much lower vacancy and steadier cash flow with fewer management headaches.

Oops! Long term LA wins the appreciation game AND the cash flow game.

 Of course you have your way of looking at things....  we have to use what is reasonably certain than compound forecast and assumptions exponentially. some may argue that estimating a 3% increase in a rent control environment is excessive but general price increase is at 3% hence that is used for both cities.

Also, although 45% expense is estimated for both cities it can also be that expenses are actually higher in LA than Baltimore, so actual expense in Baltimore may be like 35 or 38% which is totally feasible.

Well, we let property management worry about managing properties within their allocated budget right? :)

Try not to take it personal Dave!

Haha! I love this post! Mostly because of the pictures! I haven't seen anyone use pictures in a post like that yet. Maybe I only like them (and find them entertaining) because I am on your side of the argument, but it put a light of fun onto the math.

Okay, back to business. I'm with you on your math and argument and everything else. I live in LA and am working with investors buying like freaking crazy in Baltimore right now. The cap rates are some of the highest in the country and the buyers I'm working with are buying turnkey+BRRRR properties....so a turnkey company does all the work but they finance it all and they are then forcing immediate appreciation at the refi. I may actually be flying out there next month to grab up a couple of the properties myself.

There will always be people on both sides of the argument, but I love your breakdown, appreciate it because it actually justifies your stance (more people than not argue things they can't defend), and it's fun in the meantime. You made me smile with this post, so thank you. 

What kinds of properties are you planning to buy? Rent-ready, or need work, and property types?

Medium hipsterinvestment logo black300dpiAli Boone, Hipster Investments | [email protected] | 310‑957‑2101 | http://goo.gl/CozQaj | CA Agent # 01911993

Originally posted by @Ali Boone :

Haha! I love this post! Mostly because of the pictures! I haven't seen anyone use pictures in a post like that yet. Maybe I only like them (and find them entertaining) because I am on your side of the argument, but it put a light of fun onto the math.

Okay, back to business. I'm with you on your math and argument and everything else. I live in LA and am working with investors buying like freaking crazy in Baltimore right now. The cap rates are some of the highest in the country and the buyers I'm working with are buying turnkey+BRRRR properties....so a turnkey company does all the work but they finance it all and they are then forcing immediate appreciation at the refi. I may actually be flying out there next month to grab up a couple of the properties myself.

There will always be people on both sides of the argument, but I love your breakdown, appreciate it because it actually justifies your stance (more people than not argue things they can't defend), and it's fun in the meantime. You made me smile with this post, so thank you. 

What kinds of properties are you planning to buy? Rent-ready, or need work, and property types?

 lol... rent ready probably increases chances of being within budget; if someone goofs on a rehab project, can throw numbers off but if it really seems to make sense, really can't say no either.

Originally posted by @Mike Fletcher:
Originally posted by @David Faulkner:

Oops! Rent increases follow a similar trend as price appreciation, so LA rent increases at a rate ~1.5x Baltimore's.

Oops! Rents and expenses don't scale linearly with rents ... 2 single family homes in LA will have ~16% the CapEx of 12 single family homes in Baltimore, regardless of rents and price points.

Oops! 2 tenants paying $3500/mo each will be much easier to manage and a much better tenant class than 12 Baltimore tenants at $1,395, resulting in much lower vacancy and steadier cash flow with fewer management headaches.

Oops! Long term LA wins the appreciation game AND the cash flow game.

 Of course you have your way of looking at things....  we have to use what is reasonably certain than compound forecast and assumptions exponentially. some may argue that estimating a 3% increase in a rent control environment is excessive but general price increase is at 3% hence that is used for both cities.

Also, although 45% expense is estimated for both cities it can also be that expenses are actually higher in LA than Baltimore, so actual expense in Baltimore may be like 35 or 38% which is totally feasible.

Well, we let property management worry about managing properties within their allocated budget right? :)

Try not to take it personal Dave!

 3% is the lowest annual rent increase in the city of Los Angeles per its RSO.  In other words the rent stabilization ordinance mandates that the maximum annual rent increase is at least 3% every year.  In Beverly Hills it is 10%.  You can't make generalizations about rent control as it varies from city to city.  Also, single family houses cannot be subject to rent control in CA, so you are mixing up all sorts of items in your example.

Not that any of this really matters as all of these comparisons on BP between areas miss the point. Different areas have different strategies. If you want to buy a house and do nothing to it and sit back and collect rent, then I'd say a market like LA is not for you. LA is much more a value add market. Flipping for SFR and repositioning and modernizing multifamily in gentrifying areas is where the real money is.

I personally don't see the appeal of owning property thousands of miles away unless it is a hands off NNN, a multifamily operation that has 100-150+ units, or other commercial property. Locals are going to get the best deals over an out of stater and they also are going to manage the assets better even if they use a PM. E-mail and telephone only go so far and everyone forgets you still have to asset manage a property with a PM. That is a lot easier face to face in a market you know well.

Originally posted by @Matt Mason :

I personally don't see the appeal of owning property thousands of miles away unless it is a hands off NNN, a multifamily operation that has 100-150+ units, or other commercial property.

If I am correct, average home price in Beverly Hills is about $3,000,000. :) 

That isn't exactly an actively sought price point for a majority of renters. Not even close! Sure, owning a personal crib in Beverly Hills isn't too bad an idea, if you are thinking long term appreciation. Its just not a go to market for rental cash flow.


You are also correct, different areas have different strategies. Some markets are pure appreciation, some CF and some both. Think of it this way...if you really like the value add route, you can still do that in a market with strong CF potential. Nothing stops you from buying a value ad rental project in say Baltimore for instance.

Regarding investing out of state, sometimes it is unavoidable. If I happen to live in a market where the prevailing cap rate is 2 or 3% and I feel rental income should be a reasonably sizeable part of my investment strategy, then I will buy in markets with a slightly higher cap to achieve rental income objective. 

You sometimes wont always find abnormal appreciation and cash flow rates in the same market.

Originally posted by @Mike Fletcher:
Originally posted by @Matt Mason:

I personally don't see the appeal of owning property thousands of miles away unless it is a hands off NNN, a multifamily operation that has 100-150+ units, or other commercial property.

If I am correct, average home price in Beverly Hills is about $3,000,000. :) 

That isn't exactly an actively sought price point for a majority of renters. Not even close! Sure, owning a personal crib in Beverly Hills isn't too bad an idea, if you are thinking long term appreciation. Its just not a go to market for rental cash flow.


You are also correct, different areas have different strategies. Some markets are pure appreciation, some CF and some both. Think of it this way...if you really like the value add route, you can still do that in a market with strong CF potential. Nothing stops you from buying a value ad rental project in say Baltimore for instance.

Regarding investing out of state, sometimes it is unavoidable. If I happen to live in a market where the prevailing cap rate is 2 or 3% and I feel rental income should be a reasonably sizeable part of my investment strategy, then I will buy in markets with a slightly higher cap to achieve rental income objective. 

You sometimes wont always find abnormal appreciation and cash flow rates in the same market.

Doing a rehab from a distance isn't something I would want to do nor would I think it appropriate for a new investor.  

Also, you have to be careful where in a city you are doing your project and make sure you are going to get the rent increases necessary for a value add strategy.  That prob isn't going to be the case in a $40k house.  If you are doing multifamily I'd ask if your market has tenants who will pay to rent a nice apartment or are all the professional tenants just going to buy a house after a year or so.

Newbies seem obsessed with initial cash flow and gloss over attributes like the long term quality of the real estate, how they are going to manage the property, tenant quality, and exit strategies.

The successful investors I know have that Wayne Gretzky quality and are going to where the puck will be and not only focused on where it is right now.

Finally, while expensive, the average per unit apartment price is no where near $3M in BH.  

Not sure how long you are condsidering holding and on average LA is #1 nationally since 2000 for total profits (cash flow + equity)  if that matters. There is not always a direct relationship to highest initial cash flow and highest total profits.

IDK Baltimore and I am sure there is opp there too. One major difference in general observation is I think Baltimore still has many blocks of vacant abandon properties (15000+) and that is something you will just never see or experience in LA. For example you can buy fixers in Baltimore for sub 10k. A like fixer in LA might be 300- 500k. Many times exact location determains actual profits vs initial cash flow. Detroit like Baltimore has great initial cash flow too. 

One last consideration might be is the future redev opp in LA ( condos etc.) could be the actual pot of gold play vs what is happening currently. 

Good luck with your search! 

Vacant Baltimore pic

Baltimore vacant property map

versus typical LA 

Excuse my tablet typos, this thing has predictive text based on typos in the first place. 

 @Matt R. :

haha... I thought I had a disclaimer in there somewhere that this wasn't meant to hurt anyones feelings :)  LA want a rematch? 

Cool pics by the way. Not even close to the dance team though :) , like a few miles apart. There just seem to be quite a few attack dogs on here lately... maybe someone is upset with my post about airBNB. You sure you dont work for airBNB?

Seriously, where did you get the vacant building pics in Baltimore... looks like a gem for a value add project. Have an address for it?

According to census data -- there actually is more vacant buildings in LA: 93,375 than in Baltimore 54,598 but this wasnt what the post was about. Not trying to bash any city. Just need to park some funds where I can get best monthly positive cash flow. 

No matter how I tell you or anyone else not to take things personal -- it seems that is precisely what they do anyway.

One issue with just investing for initial cash flow for outsiders is they end up in one of those abandon red zones pictured above. You will even see some who posted here offering stuff in those locations. Take a gander at the rest of the local investors and what they think of that area moving forward. Hopefully the investor ends up with the exception but many times they end up next door to one of the pics above. Look they make many thousands when they sell these crap holes to you.  Many of these sellers sell you on the initial cash flow and not the best long term fundamental based investment. That is just how some of these guys operate folks. It is a merely a commissioned sale versus a well thought investment in some cases. 

Originally posted by @Mike Fletcher:
 @Matt R.:

haha... I thought I had a disclaimer in there somewhere that this wasn't meant to hurt anyones feelings :)  LA want a rematch? 

Cool pics by the way. Not even close to the dance team though :) , like a few miles apart. There just seem to be quite a few attack dogs on here lately... maybe someone is upset with my post about airBNB. You sure you dont work for airBNB?

Seriously, where did you get the vacant building pics in Baltimore... looks like a gem for a value add project. Have an address for it?

According to census data -- there actually is more vacant buildings in LA: 93,375 than in Baltimore 54,598 but this wasnt what the post was about. Not trying to bash any city. Just need to park some funds where I can get best monthly positive cash flow. 

No matter how I tell you or anyone else not to take things personal -- it seems that is precisely what they do anyway.

 I think we need to understand abandon vs vacant. LA has 50 times more stock? and should have more vacancies but not higher vacancy rates. Nothing personal taken, it is just per captita math here. 

 @Matt Mason :

I hope this isn't where I get to explain or defend my RE or investment experience. But regarding some of your questions, the intriguing part is whether or not rent remains flat for the entire holding period or if an 8% vacancy rate is used, the primary investment objective is still intact and almost unaffected. 

Even if a 10, 15 or 20% down scenario, and use of conventional financing at 4.07%, the monthly cash flow is still positive. 

In LA however down payment would have to be almost 52% just to break even. The difference is materially profound. It is a fact you cannot ignore.

Originally posted by @Mike Fletcher:
 @Matt Mason:

I hope this isn't where I get to explain or defend my RE or investment experience. But regarding some of your questions, the intriguing part is whether or not rent remains flat for the entire holding period or if an 8% vacancy rate is used, the primary investment objective is still intact and almost unaffected. 

Even if a 10, 15 or 20% down scenario, and use of conventional financing at 4.07%, the monthly cash flow is still positive. 

In LA however down payment would have to be almost 52% just to break even. The difference is materially profound. It is a fact you cannot ignore.

 You might be assuming initial cash flow equates to total profits? It is easy to fall into that mindset for sure but historically there is much more to a real estate investments profit potential. As I mentioned Detroit has great initial cash flow as well. As long term investors some might want to take a step back and look into the overall fundamentals that create the real estate values in the first place like jobs, supply and demand, schools, crime, appreciation rates, Landlords abandoning in some places etc...On paper anything is possible but understanding real history can make for more reality based investment decisions long run perhaps. 

@Mike Fletcher Baltimore?  Why Baltimore?  Of all places, Baltimore?!?!  Sorry, I digress.  I just remember reviewing property appraisals for $5K row houses back in the day.  And those $5K row houses didn't sell.  Combine that with The Wire and it's one market I can't fathom investing there.  I know, so narrow minded and risk averse.  I'm also lousy at parties. 

That said, I think you're numbers are pretty accurate.  Maybe rent increase (and values) will keep growing at the same rate over the next 10 years.  It seems like 1/2 of the people on BP are in the "it's never gonna stop!" camp and other half are in the "this is unsustainable!" camp.  A decade from now history will have decide who is popping bottles with celebratory toasts.  However, in favor of other comments, I do agree that the cap-ex will be higher when you spread it out over 12 homes as opposed to 2 homes.  A kitchen refresh will have to be "nicer" in Los Angeles but not 6 times as nice (at least with costs) as one in Baltimore.  Costs to do things (read: repairs, etc.) are higher here in California that a lot of midwest but it's not proportional to the delta in terms of rents.

But in the favor of Baltimore, I think you missed out on compounding the *extra* cash-flow.  Maybe it's accounted for but I didn't see it.  With the extra $68K per year you can basically buy another Baltimore property every two years.  So that 13th property that you buy in Baltimore in on the 25th month with the *extra* cash-flow has 8 years of rent, profit, etc.  Now this doesn't really work because you get taxed on the income, you only have depreciation, there's no mortgage interest, etc. so it isn't quite that linear.  Maybe it's every 3 years because of Uncle Sam, but you can keep adding.  In Los Angeles you can't even buy your 3rd home with 10 years of cash-flow.  To look at it slightly differently, if you took that $68K in extra cash-flow and put it into a syndication with a 7% preferred payout you still have 9 years compounding at 7% per year.  So that $68K becomes $125K.  At least in proforma theory, which I think is the fun of the exercise.

Anyway, you can mess around with this stuff all you want.  Play around with assumptions, test what-ifs, It's a good exercise.  People that have $500K in paper appreciation over the last 8 year in California won't care.  It's more than they would have made in a "cash-flow market" and with the higher property values they're most likely cash-flowing just fine at the moment anyway.  Other cash-flow investors like the pseudo-annuity aspects of their properties, not having to find something value add to make money, etc.  To each either own.  

So my only contributions are basically:

1.) Compound the *extra* cash-flow.

2.) Ugh...Baltimore?  Just ugh...

:-)   

Originally posted by @Mike Fletcher:
 @Matt Mason:

I hope this isn't where I get to explain or defend my RE or investment experience. But regarding some of your questions, the intriguing part is whether or not rent remains flat for the entire holding period or if an 8% vacancy rate is used, the primary investment objective is still intact and almost unaffected. 

Even if a 10, 15 or 20% down scenario, and use of conventional financing at 4.07%, the monthly cash flow is still positive. 

In LA however down payment would have to be almost 52% just to break even. The difference is materially profound. It is a fact you cannot ignore.

 Huh??? 

I am not even going to comment on your made up numbers and scenarios. Lets just say both of my properties cash flowed from day 1 with a 25% down payment so yes I can ignore your silly assertion that you need 52% down payment to break even. Sure if you go on the MLS and just start looking at houses you can find that, but that is not an investment.

Also, if you are going to underwrite real estate, you need to know how to estimate rental growth and vacancy for each investment and yes they are going to be different for different assets and different markets.

Why the obsession about a market 3,000 miles away from you anyway?  Seems pretty bizarre.

Yes it is some crazy bizzaro world to compare these two cities as comparable in any average real investor way. One has thousands of abandon properties and many were recently abandon, almost like a bomb went off and the other is a thriving top to bottom healthy market flush with investors from the entire planet. Do folks really think those buy and hold investors in the pics above did well? Those are total losses as the entire street is abandon. This does not exist in LA and or so rare you would have to spend many hours to find one or two in that abandon stage and it would not remain abandon for very long on average. 

 @Matt R. :

 You might be assuming initial cash flow equates to total profits?

Clearly you haven't reviewed the initial post. This isn't a cash flow only perspective but total profit which includes appreciation. In markets with extremely strong CFs and somewhat average appreciation, total profit does exceed LA's in some markets. If we start talking Detroit, now you really got yourself in trouble.

I can randomly google map dart throw any location in those Baltimore redzone suburbs and street view abandon properties. Sometimes several, sometimes just a couple, sometimes almost the entire street. You can see a row of 10 with 9 abandon. Now if can get ahead of the turn around on some select streets, blocks or hoods there could be tremendous opp. This is where being local pays off. Don't think for a minute that some commissioned sales person in LA or their cohorts know where in that city is good for the future. That would be just plain stupid sh#% thinking. 

Originally posted by @Mike Fletcher:
 @Matt R.:

 You might be assuming initial cash flow equates to total profits?

Clearly you haven't reviewed the initial post. This isn't a cash flow only perspective but total profit which includes appreciation. In markets with extremely strong CFs and somewhat average appreciation, total profit does exceed LA's in some markets. If we start talking Detroit, now you really got yourself in trouble.

 Understood. Here are the facts according to CoreLogic. Top 3 cities since 2000 for total profits ( sfr averages) nationally are LA, SF and San Diego. Agree or disagree it does not really matter I guess.  Guys can make money anywhere still and these are just the national averages. Buy and bolder investors might be interested in why that is the case so they can make better investment decisions in their futures. Baltimore vs LA...on average during the sametime period is a bit absurd to take seriously on average. 

 @Matt R. :

Why all these attacks though? The numbers say Baltimore beats LA from a CF standpoint. I say the funds is going to the market with strongest CF potential; there should be no need to further explain or justify.

So you either are an airBNB employee or a rams fan. Not sure which it is.

I really dont know or care what corelogic or whoever else told you. What I do know is that the federal reserve tracks home price growth for most of the metros going back 30 or 40 years. The rate of growth for both LA and Baltimore is a matter of fact -- you just look it up. 

So I know if I am investing $1.5 mil in both markets today the value 10 years is just math. I am sure you will tell me some story about how in LA you have a slightly different time value of money concept so the factors is slightly different.

We also know what rent is for both markets and can estimate gross income, expenses and net operating income from that.

You combine both CF and appreciation and I tell you Baltimore beats LA . It doesn't matter what corelogic or your nephew told you. This is the whole idea behind independent research not group think. If I analyze the data and all signs point to buy, corelogic can scream sell all it wants to.

Originally posted by @Matt R. :

Yes it is some crazy bizzaro world to compare these two cities as comparable in any average real investor way. One has thousands of abandon properties and many were recently abandon, almost like a bomb went off and the other is a thriving top to bottom healthy market flush with investors from the entire planet. Do folks really think those buy and hold investors in the pics above did well? Those are total losses as the entire street is abandon. This does not exist in LA and or so rare you would have to spend many hours to find one or two in that abandon stage and it would not remain abandon for very long on average. 

 I thought I heard the cat meowing again... you want some ice cream with that? I heard it goes well with whinning.

HOLY OMG...this is a great thread!  One thing that hasn't been mention no matter if the locations are LA vs. Baltimore; San Diego vs. Detroit; San Francisco vs. St. Louis; or New York vs. Kansas City....the fact that you can spread your risk over more doors in the cheaper markets can be a factor that many investors could take into account.  I know it's a simple point...but an important one in my humble opinion.  Thanks for the great "what if" scenario with the numbers breakdown @Mike Fletcher!

Medium outbackreinlogo 984x960Jon Lee, Outback Real Estate Investment Network | [email protected] | 702‑518‑3652 | http://OutbackREIN.com

Awesome Thread!  Thanks @Mike Fletcher and @David Faulkner for the great discussion on this topic!   

if I may throw in my .02, this is how I would position 1.5 Million in LA or OC. I would purchase 3 value add SFR (distressed, off market what have you) for about 1.65 million (550k each which is my sweet spot). I would rehab to a probable appraised value of 650 to 700k which would give me about 300 to 450 k of built in equity into these 3 properties. I would lease them out at 3k each for a total of 9k gross rents / month.

What do I have now?

1. 3 SFR with gross rents of 9k / month.

2.  300 to 400k of value add equity.

3.  1 day max of management time (probably more like 3-4 hours) per month to manage these 3 properties.

4.  29 days left in the month to make real money at my job and business.

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