High Appreciation vs. High Cash Flow... What's your pick?
Rental Property Investor · Member since 2018 · 15 posts · 28 votes
Hi BP Community,
Need your input!
Save to afford a project in Austin, TX? - High appreciation potential
Start buying rentals in Killeen / Copperas Cove / Harker Heights, TX? - Positive Cashflow, guaranteed rent if military tenants.
Hi BP Community,
Need your input!
Save to afford a project in Austin, TX? - High appreciation potential
Start buying rentals in Killeen / Copperas Cove / Harker Heights, TX? - Positive Cashflow, guaranteed rent if military tenants.
Matt, I'm going to make the case for #1!
Over time, owning a good piece of property in a proven appreciating market will build more wealth than buying a cashflowing property with little hope of appreciation. Personally, I'd rather have 80% leverage on a good property in Austin that's appreciating reliably (given the facts on the ground in Austin) than a cashflower in Killeen.
I say "personally" because personal circumstances make the difference. I have a career outside of real estate that provides a healthy income. My wife also works, so we're dual-earners -- and we're both happy in our careers, too! We don't need cashflow right now, but we're excited about building wealth.
That's why we bought an expensive duplex in Los Angeles in an historical neighborhood just outside of Hollywood. If the property appreciates half as well as the longterm historical average, I'll be able to refi out my daughter's college tuition when she goes in 15 years. That's more important to me than $150/mo/door or replacing my W2 (because I own my business, so I cut my own W2, so I got no problems being a W2 employee!).
One other case to make for option #1: even if your goal is to replace your income, you might be better off letting your capital appreciate in an Austin property for a couple of years. Five or ten years from now, when you're ready to replace your income, sell the Austin assets and 1031 exchange them into a cashflowing portfolio in Killeen or anywhere else.
So, it really depends on your circumstances. What are your circumstances?
Also, I'm glad you're not somebody who equates appreciation with speculation. In Indianapolis or Cleveland, such may be the case. But in LA or Austin or Seattle, appreciation is real.
Appreciation is the real wealth builder, but its not something you can underwrite today when analyzing a deal, because past performance is no guarantee of future returns. Sure, you can buy in a high growth area and reasonably assume that the growth will continue leading to a higher IRR on exit. Not a bad idea.....if it cash flows.
But it has to cash flow on day one, as specially if you are scaling. There's a place for taking a long shot in everyone's portfolio, ie betting on appreciation. But, if you are in the business and buying on skinny margins at volume, think twice.
Cash flow is more important for longevity. Riding the appreciation wave is fun and can last a long-time, but the wave will crash ashore at some point.
@Matt Camilliere
Can you do both? Won’t the extra cash flow help buy appreciating property? If properties don’t have positive cash flow don’t buy them. Leave that to speculators be an investor not a speculator. Buy low- sell high-positive cash flow in between!
@Matt Camilliere when I buy and hold, its always for 1 and 2. Both. Although hard to do, its worth the wait and always a off market deal as MLS does not provide either one very well.
#2 - Appreciation is more of a gamble and is making assumptions on the future. Cash flow you should have a good idea going in and how much it can improve by. Good cash flow properties also are always hot commodities.
Over time, owning a good piece of property in a proven appreciating market will build more wealth than buying a cashflowing property with little hope of appreciation. Personally, I'd rather have 80% leverage on a good property in Austin that's appreciating reliably (given the facts on the ground in Austin) than a cashflower in Killeen.
Well, in my defense, I know the cash flow in Killeen 100% today.
How sure are you that Austin will continue to appreciate over the next 10 years? I'll take an O/U number if you want, but it's not 100%. Add in that you'll be paying a higher price for the same and while that means a larger absolute gain, percentage-wise it may not be that much gain.
Which means if you have to stretch to reach, you have less for other deals in the intervening period.
Anyways, like debating since I get asked this by clients and am willing to learn. However, I guess it boils down to whether $1 in Killeen in 2030 is >/< than NPV of the same in Austin in 2030.
@Matt Camilliere
Can you do both? Won’t the extra cash flow help buy appreciating property? If properties don’t have positive cash flow don’t buy them. Leave that to speculators be an investor not a speculator. Buy low- sell high-positive cash flow in between!
You are not the first that I have seen refer to investors that buy for appreciation as speculators and not an investor. Why? If I am in a market with growing population, no where to build, robust employment, income growth that far exceeds national average and I purchase for appreciation, how is this not investing. I've researched the market and use that research to make an investment.
If you believe that cash flow has no risk, you need to evaluate what happened to rents/vacancies in Detroit, las Vegas, and many Arizona cities in the Great Recession (R). During the GR there were many locations that experienced no decline of rents or significant change to the vacancy level, but there were other locations that suffered huge rent declines/vacancies. Cash flow is not guaranteed.
I purchased an RE that I projected as cash neutral with a value add of ~$60K (~$60K cost for a ~$120K increase value). I also was expecting short term (3 to 5 years) appreciation of ~8%, but used 4% in my pro forma. I purchased it and the value add produced closer to $100K (value add got an assist by market appreciation), but after the refinance it was still around cash neutral. Today the property using the 50% rule (which is very conservative in high rent markets) has a projected cash flow of ~$1k/month. It has appreciated far greater than 4% annual rate and probably over the 8% that I was expecting (I have not calculated the compounded appreciation). This property has appreciated $4.3K/month ($3.4k/month when subtracting out $60K value add costs) over the hold period.
Was it speculation? I consider it investing. I knew what the market indicators were and used that information in my evaluation to derive a conservative pro forma. 6 years in, this RE has out performed the conservative pro forma. The value add produced better return than my conservative projection, the property appreciation has been better than my conservative projection, and the rent appreciation has been better than my conservative projection. Seems like an investment.
I’m a simple person.
You have very good thoughts and discussion points and you very well could be correct.
I will look up Definition of investor and speculators
Been investing for 40+ years.
simple answer is to your question is 2008/9.
if you can rent for less than you can buy -why buy?
I believe that you can buy cash flowing property that appreciates.
The question should not be which strategy is correct but which strategy is right for you. Based on your goals, exit strategy, wheer you are in the investment lifecycle you would need to make a choice that is specific to your circumstances.
Personally I agree with what Jonathan and Bryan are saying.
Aren't property taxes high in TX and would be even higher in a quickly appreciating market? Appreciation to make only makes sense if you have a plan to use it on something else...but that most likely requires taking on more debt. More debt can be harder to manage both finicaly and or emotionally...
Cashflow is great, but like others said it is a lot slower.... And can be wiped out rather quickly with some bad luck and or bad tenants.
Also, military is never guaranteed rent. Lot of protections on military side and it's easy for them to break a lease. Yes, you can go after them through their chain of command but trust me....there's plenty of military members who are not good with money or wouldn't make good tenants. While they deserve your respect, don't assume they'll be the perfect tenant and definitely don't think it's guarnted rent.
You should create a plan and find a property that is best for you and it'll likely have a balance of cashflow and appreciation. But to get the best, you have to define what best is before you start. The definition should be more then numbers you plug into a spreadsheet...
@Steve Morris, I appreciate your friendly tone! I also like cordial debating in these forums.
Let’s put some numbers to this debate...
In a cashflow market like Killeen, what’s a good cash-on-cash? 12%? So, a $100K investment should yield $12,000 — plus the tax benefits and principal pay down, etc. etc.
I’m not familiar with Austin, so let’s talk about LA. Let’s assume 75% leverage and the longterm home price appreciate rate of 4.87%/year. This number comes from the Case-Shiller Home Price Index for metro LA.
$100K buys a $400K (hypothetical) property, so the average annual appreciation on that would be $19,480 — plus tax benefits and principal pay down, etc. etc.
Appreciation isn’t bankable like rent checks, you’re right. But rent checks don’t compound like appreciation. Then again, if you use rent checks to buy more rent checks, that can snowball nicely.
Lots of way to skin this cat, right?
I agree with Jonathan and several others.
As long as keeping solvency, in the long run appreciation is a much better bet than cash flow. Cash flow keeps you live, appreciation builds wealth.
If you invest in good neighborhoods in promising cities, in the long run you should expect decent appreciations, probably far more than the cash flow accumulated.
I also disagree with the saying that cash flow is more predictable. We seldom count on those unexpected events such as tenants trash your properties, or leaking cause severe damages etc. Unfortunately, unexpected always happen.
So far for me, the cash flow that I actually got is far less than I projected. And the appreciation that I got is far more than I imagined!
I’m a simple person.
You have very good thoughts and discussion points and you very well could be correct.
I will look up Definition of investor and speculators
Been investing for 40+ years.
simple answer is to your question is 2008/9.
if you can rent for less than you can buy -why buy?
I believe that you can buy cash flowing property that appreciates.
>if you can rent for less than you can buy -why buy?
In an appreciating market, the buy cost is fixed but the rent is not. I care less if on year one I can rent for less than buy if on year 10 the rent is 10X the living costs associated with the purchase. It is called buy n hold. The hold implies I am not exiting on year 1.
>I believe that you can buy cash flowing property that appreciates.
I believe that for buy n hold investors, your statement is always true of the appreciating RE. The reverse is not always true (many cash flow assets do not appreciate more than inflation).
My low initial cash flow properties all have current rent to acquisition price ratio above 1%. Two are above 4%. They cash flow great. I suspect per unit, their cash flow today is higher than virtually all areas that initially had a better cash flow. Appreciation guarantees cash flow over a long hold duration.
I also disagree with the saying that cash flow today is more predictable than a value 10 years down the road.
Pardon the edits, but that was my point.
He just said either/or so I made the assumption Killen has better CF/$ than Austin, but 10 years from now Austin will appreciate at higher % than Killen.
Cash flow predictions are just as much of a fools errand as appreciation predictions. Invest long term, in areas you believe in.
Cash flow vs appreciation usually becomes a pro-cash flow argument on this forum because most people can't afford the appreciation game. The appreciation game is for primary & expensive markets ($5m+ net worth at least). Most people can't afford to let an asset sit and make them wealthy.
Most of the experienced REIs do both. Cash flow & Appreciation.
@Matt Camilliere
I think it’s possible to have both...if you do commercial.
Commercial values are based on NOI and cap rates. So if you're NOI (and thus cash flow) goes up and even if your cap rate stays the same, you have appreciation.
@Matt Camilliere First off what a great question and conversation to bring up.
To keep this most constructive I believe their needs to be some ground rules of not chasing the minutia of "what-if's" in the un-stated details such as arguing "IF" high appreciation will happen etc etc. Best to keep this to the assumption that the high appreciation WILL incur and high cash flow WILL incur, and that there is a required either or, not a 3rd option of both and so on.
Ok, ground rules stated:
I believe this is a perfect example of the right investment for the right investor, in the right market. Both are profitable, just in different ways and times but the net result could be very different. For example say a person currently has a large cash-flow, therefore additional cashflow could actually be detrimental as it may raise tax bracket and decrease net capital kept. Remember step 1 is to make $ but step 2 is to keep it, what's the point of making a million dollars if your loosing 980 thousand a week later.
All things being equal in the profit potential, I'd say the answer is in the business plan and tax implications, if that cashflow is needed to do more immediate capital deployment OR if it's better to "build the war chest" of equitable gains. If I don't need it I will take the tax free route of equitable gains because cash is worthless in hand unless I have a use for it at hand. Remember inflation is like acid slowly eating away at cash making it a little less every day, so it must be actively deployed to preserve itself, via equitable gains safeguards and keeps it working 24-7 as a perfect hedge against inflation.
@Matt Camilliere Many experienced investors I know have a mix of properties for cash flow and others for high appreciation. It's good to have both, if you can. The cash flow will put money in your pocket today. Properties with high appreciation (as long as it cash flows and you're positive) will give you the cash when you're ready to sell and want to consolidate or move on to other projects. Hope that helps!
I analyze and buy based on cashflow. I'll take appreciation when I see it, but I haven't seen enough yet in my portfolio to make it worth realizing. Most of my properties are in small towns, so while those markets weren't hit hard in 2008 (I bought my first house in 09), they haven't had significant appreciation since then, either. But cash flow is solid. I'm ready to sell all of them, hopefully 1031 into something bigger, but the market isn't ready for me to sell them yet, so I'll keep collecting the cashflow.
We lived in Silicon Valley from mid 1980's to 2018; our properties there were entirely market appreciation-we sold one in 2016 and another in 2018. Got lucky, and huge gains, could have turned out very differently.
With the profits we bought properties in the PNW, these were completely based on CF-appreciation if any, will be a bonus.
In the meantime have retired in the PNW and our main interest is retirement income from CF. So far so good. Who knows what the future will bring.
Always have money, or access to money and you will be a winner.
@Matt Camilliere CASH IS KING! Cash Flow all the way
A balance of both...Appreciation is where you build wealth AND what allowed me to quit my job - NOT cash flow.
Cash flow is your safety net. It protects you if rents drop and yes gives some passive income, but if you want to truly build wealth, you want appreciation.
My first units were all purchased in an appreciation market, not a cash flow market, but as you build wealth, appreciation shows up in your net worth on your balance sheet. As they grow you can leverage those assets to continue buying and scaling and allow the compound effect to really work for you. If you only go after cash flow, you're missing out on the greatest benefits of real estate investing in my opinion.
My purchases were deals that were below market and were cash flow positive, but if I had bought better cash flowing deals in a market that didn't appreciate, I don't believe I would be as far along as I am today.
i would say 3. find something that cash flows but also appreciates. i feel like people tend to forget you can do both. maybe it doesnt appreciates as fast or cash flows as much but you get best of both worlds. all the my properties have cash flowed and appreciated Farley well.
I buy for forced appreciation in markets that cash flow. Market appreciation is nice as well, but market appreciation is less important to me than forced appreciation that I can create on the purchase side. For example, I’d rather purchase a home for 100k that needs 10k in work that will value at 150k that appreciates on average of 1% per year where I don’t need to leave any of my personal money into the deal at the end of the day, than purchase a 150k property where it appreciates 3% per year but where I had to leave 37.5k (25%) into the property in order to purchase it. If I buy for forced appreciation every time in markets that cash flow I will build wealth much faster and safer than if I bank on either appreciation or just cash flow.
@Jeff Abel
After depreciation/deductions, I would doubt you'd have any significant tax burden.