Cash Flow vs. Appreciation: What Experienced Investors Know About the Debate That You Don’t


I am once more sitting on a raised deck in a rental home in Sandusky, OH on Lake Erie. I wrote about this place a month ago or so. At that time, Patrisha surprised me with a 2-day getaway (read about it here), and I liked it here so much that we have come back – this time with the twins. I just completed a remodel of our house, which I wrote about here, and it is time to decompress once again.

I am, after all, of a ripe old age of 40, and I do need to take more breaks than I used to. This place, Sandusky bay, just does it for me. Here we are on a ferry crossing the bay to Kelly Island, and my kids decided it’d be good to stick their heads out the window and serenade everyone with a rendition of Steve Miller Band’s Abra Ka Dabra.

I have to say, there are very few things in life that put the meaning of the word “perspective” front and center. Few people who make me think. My wife is at the top of that list, and my children are in close second. When it comes to real estate, my friend Brian Burke stimulates me in ways no other person can.

Hear that, Burke? You stimulate me, man. If I were you, I’d be concerned! Run with that. (But not too fast, ’cause just like me, you’re not the freshest chicken in the cook no more.)

I was not planning on writing an article today, but I am inspired to teach this morning. Thank my children; they bring it out of me. So, while they are busy doing their Kumon math and reading with mom, here we go.

Related: Cash Flow vs. Equity: Which Pays Off for Investors in the Long Run?

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What’s More Important: Cash Flow or Appreciation?

This question keeps coming up in the Forums and on the Podcast. Everyone has an opinion, but everyone aside from Ben Leybovich is wrong.

Serge Shukhat is reading this right now, and I bet he’s thinking — Leybovich, what a schmuck; there he goes again!

Whatever, dude. You know I’m right. 🙂

The answer requires quite a bit of perspective, which we develop after years in the game and which cannot be expected to be easily accessible for new investors. Let’s put this in perspective for you – this will be shorter than you’d think; I ain’t got time to mess around, considering my agenda today includes the beach, racing carts, and the water park. Here we go.

Why Do We Need Appreciation?

We need assets to appreciate because equity is the primary driver of wealth. While it’s true that cash flow pays the bills today, equity appreciation makes us rich and allows options. What options…?

  1. To re-leverage the asset and use the cash out to bridge into a larger asset base.
  2. To sell the asset and exchange the equity for a larger asset base.
  3. To sell the asset and ride into the sunset, leaving your kids something to remember you by aside for your shiny personality.

Those are the 3 basic options that we have when we have equity – nice place to be, indeed.

Why Do We Need Cash Flow?

Simple. Cash flow allows us to hold onto the asset long enough so that it can appreciate and allow for the three options we discussed above. We can help speed things along through value-add strategies, but those also take time. While it’s true that once you reach a critical mass, you can indeed reverse the time paradigm and arrive at a place where time is helping you instead of hindering you.

Once there, the cash flow has value that stands alone, disengaged from equity – you don’t necessarily need any more appreciation once there. But until you get there, which is the place where most of you live today, the only function of cash flow is to hold you afloat. To buy time, so to say.

Why Do Sophisticated Investors Underwrite to the IRR?

I’ve written about the IRR a lot; please look up the other articles. Having said this, have you ever wondered why big time investors never give a hoot about things like cash on cash (CCR) and capitalization rate (Cap Rate), and all they want to know is the IRR? Why is this?

There are many reasons, but the basic logic is that they don’t care about stand-alone income. These people have plenty of money to live on. These people are accomplished professionals and investors. What they are concerned with is wealth, not income for its own sake! The IRR tells them how much real wealth they will create with the investment, and here’s why:

The IRR tracks all of the cash flows, right? Say, yes sir, Mr. Leybovich. Well, if you’re going to track ALL of the cash flows, then you must project the final and all intermediary exits of capital since the sale or refinance of the asset represents the largest positive cash flow event in the life cycle of an investment.

While amateurs perceive long-term hold as just the long term hold for cash flow, the sophisticated investors know better. They know that those hundreds of thousands and millions of dollars of their wealth will be created not through cash flow, but by liquefying equity.

They want to know what the exit of capital will look like before they put capital in! They want to know how much and how soon. They want to run a Net Present Value of these events to compare them to other available to them opportunities.

The side benefit of this, of course, is that this line of thought requires us to underwrite the entire lifespan of the investment beginning to end. It requires us to make our best assumptions and projections of EVERYTHING.

Related: Should I Invest for Cash Flow or Growth? An Investor’s Analysis

So, They Don’t Look at Cash Flow at All?

Be honest – this is indeed what you are thinking now, isn’t it? I did sorta make it sound like cash flow ain’t important…

Not at all. In the world of income-producing property, income drives the setting of value — NOI to be specific. This means that in order to sell for more than we paid or to be able to refinance, the NOI has to increase.

Cash flow pays for the life of the investment until wealth can be taken off the table. We know this, and that’s why we don’t care about appreciation – only the cash flow. We know that if we take care of the cash flow, which requires buying a very specific kind of asset, the mechanics of property valuation will automatically create equity and wealth, no question.

You see, a different perspective. Some guys worry about cash flow because that’s all they care about and can see. At best, those guys are buying themselves a job — forever. Others, who are in the minority, realize that cash flow does not build wealth, but it backs into wealth if you’ve bought the right kind of an asset, in which case we work very hard for a while, but eventually equity starts to work for us.

As such, there should never be a question of equity or cash flow. There is cash flow for the sake of cash flow, and there is cash flow for the sake of wealth represented by equity.

Where do you stand?

Be sure to weigh in with a comment below.

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.


    • Adam Christopher

      The article was refreshing. Some people can get really crazy about cash flow and ignore appreciation. Some argue that you can’t count on appreciation, so you have to ignore it. I would argue that if you buy a property for 75 cents on the dollar, it will appreciate. I don’t fully understand all of the acronyms. I will do some homework and come back to it.

      I’m trying to skip the refinance step. I have two rentals that have really good cash flow. The cash flow will support the purchase of house #3. I think I should be able to buy a house every 5 years and have about 5-10, buy the time I’m 65. I really like my day job, so even though I have had success in real estate, I have no intention of quitting my job and doing real estate full time. I prefer real estate as a part time thing. I like laying a floor once every 5 years. I wouldn’t want to do it every 6 months.

  1. Talking about perspective, Ben, there is a Spanish song by Ruben Blades that goes “La vida te da sorpresas, sorpresas te da la vida!” (life gives you surprises). In the song’s story Peter “The Knife” (Pedro Navaja) a notorious gangster attacks a “defenseless” prostitute to rob her, at knife point. But the prostitute just happened to be carrying a gun and was holding it under inside her bag, precisely at that moment of the attack and kills Mr. Navaja. Big surprise for him!

    One can calculate the IRR and project every penny, and make decisions about the investments that way (which, granted, is far superior). But, life is full of surprises and twists and turns, and that calculated IRR plenty of time doesn’t develop as planned. And other investments fare much better. You yourself have written about some of your investments that you had to “stabilize”. And I would imagine that the exact details of the “stabilization” was not in the original IRR calculations.

    Life gives you surprises.

    Now, that is perspective.

  2. Brian Burke

    I agree with a lot of what you’ve said. I do agree that Serge is probably reading this and thinking “what a schmuck” (that’s OK Serge, I was thinking the same thing) and I also agree that IRR is the best metric with which to gauge the quality of income property.

    I also disagree with a couple of things. The first being that I stimulate you, I’m scared to even attempt to comprehend that one. LOL.

    The second is that big-time investors never give a hoot about cash on cash return (CCR) and Cap Rate.
    Not really true, it’s just that us pros don’t think about it in the same way that most people do.

    Sophisticated investors in syndicated offerings are typically curious about the composition of the IRR — how much of that number is a result of cash flow and how much is a result of reversion. There is no bright-line rule, but folks tend to favor a waterfall that has a healthy representation of CCR. As a syndicator, I care about CCR because I offer my investors a preferred return — thus the investor receives 100% of the profits from the deal until they reach a specific return. As an example, if I’m putting together an offering with an 8% pref, an acquisition is more desirable to me as a sponsor if the CCR close to or more than 8% because I know that I’ll accumulate less pref to future years and I’ll start participating in the promote sooner. It’s also more desirable to the investor because they are getting current cash flow on their investment.

    I also care about cap rate, but not the same way most people do. Watch the BP forums and you’ll see comments on a daily basis about how folks are looking for X cap rate or Y cap rate, and for anything lower they either don’t buy or they say that whoever did buy paid too much. Not so fast…cap rate, if used properly, is a very useful tool. It’s just that most people don’t use it correctly. This is a response to Ben’s post so I won’t go into detail but fortunately for Ben I’ll write my own article on cap rate. It would take up too much space here and take the focus off of Ben. And we all know that Ben likes to have the focus… 🙂

    • Ben Leybovich

      Brian – Serge and I are going fishing next week. We’ll work our differences out then. Wanna come along? You could fly right into SV 🙂

      If I understand you, and I’d like to think that I do, you care about a set of CCRs – snap-shots in a time-line which represent the composition, as you say. The IRR is a function in part of this progression of snap-shot.

      I stand corrected about the Pref – yes, of course, pref is measured by way of annualized CCR. You got me…not a chance will this ever happen again 🙁

      CAP rate is a market metric, and those who understand that use it correctly. CAP rate is not a metric of investment return, and we don’t care about it as such…

      Brian – see what I mean – you stimulate me. And now, I think I’ll go mow the lawn; you know – for relaxation purposes… You got me wound tight

      • Brian Burke

        Be the third wheel while you and Serge bicker about who is a better investor? I’ll pass and read the cliff notes because I already know the answer.

        As to CCR question…if your deal is a 17% IRR and half of that return is paid out during the hold period and the other half is paid upon sale, you’ll attract a different investor than if your 17% IRR is 10% cash flow and 90% from the sale. Many investors would consider the second scenario to carry higher risk than the first scenario. And it’s very likely that it does.

  3. Ben I have been bored and was really hoping for one of those notorious posts that bring the lunatic fringe right out on center stage. This was all good information from a 40 year old family man who cares about his fellow investors long term well being.
    No B.S. man what happened, who got to you?
    I really thought I could count on you- now what am I supposed to do?
    Maybe they still print Doones Berry.

  4. Che Chiu Wong

    Awesome Article Ben! Great to meet another gentleman who doesn’t look purely on cashflow.

    Particularly like your part where you say “until you get there, which is the place where most of you live today, the only function of cash flow is to hold you afloat. To buy time, so to say.” That’s land-banking in its essence.

    Aside from IRR, a metric which I like to see is pay-back period, basically how many years before I get all my money back. (This assumes I am prudent in cashflow management, by keeping my cashflow in the positive side with some buffers). On good ones, it can be 1 years or less (refi 100% of my money), on the others it may take longer.

    Do you use the pay-back period metric? The reason I use it is because if for example, I know I can get my money back quickly AND it is almost certain that good cashflow / good equity , I wouldn’t bother too much in going through the IRR calculation — I KNOW it is a good deal already!

    Great article!

    • Ben Leybovich

      Well, Che, the pay-back period is essentially the CCR; at least that’s how I think of Cash on Cash return. It’s useful, but only up to a point. Personally, I finance my acquisitions 100%, in which case my CCR is infinite. But, what’s the point?! I could be making cash flow of $10/month, but because I have no skin in the game, my CCR is infinite…

      What if, on top of that, there is no real value add? What is the benefit of this investment then? See what I mean – CCR is sorta pointless, at least the way most people think of it. It is good to know how quickly you’ll be made whole, but only as part of the big picture of creation of value.

      Thanks so much for reading and leaving a comment!

  5. I can’t believe I just wasted 7 minutes of my life reading this… Completely useless. Doesn’t make you think doesn’t help you make smarter decisions and 70% unrelated babble by the author. Next time when you bring such an important subject to table, please make sure to shed some light on the subject at hand and don’t just fill a page with words.

  6. Tim Shin

    Interesting article, Ben. I guess maybe this is why buying “PIGS” is not worth it even if the cash flow is “good”? Because you’re buying yourself a job with little room to appreciate if at all. But the question is, how do you get into high cash flow, high chance of appreciation properties? Does this mean you have a high cost of entry point even if you plan to force appreciation by picking up that poor piece of property that needs some TLC if you want to buy a property with a high chance of appreciation? Or (and?) are you looking for properties that are in developing areas?

    I find that if you can identify developing areas, the cost of entry is lower than an area where appreciation is currently occurring but the properties are being sold for more than they are worth and can’t cash flow at those prices with current rents in the area… What do you do?

    • Ben Leybovich

      Tim – as long as you can push the NOI, the exit valuation will be higher than what you pay…unless, of course, the exit CAP inflates more than accounted for in your underwriting (as tends to haapen with pigs)… The rest of it hasn’t changes in 100 years…

      • Tim Shin

        Ben, Thanks for the reply. I think I’m still a little foggy on forward modeling NOI, CAP, and ultimately IRR. Do you have any plans to do a webinar on this? I think that would be fantastic for people who are a little farther along than the typical beginner.

        • Ben Leybovich

          Tim – perhaps my dear friend Brandon Turner can do one. First, however, I’d have to teach him 🙂

          Personally, I agree with you. I’ve beet trying to get Josh and Brandon to let me do webinars for more advanced people here on BP. So far with no success, though.

          As far as doing it on my site, I’ve considered it. But, I have an aversion to webinars – everyone is doing them, and it’s kinda “tired” to me.

          What you are asking is not a “mechanics” question. I know it seems like just math, but it’s not. It is a “vision” and perspective question. I’d have to go way back in order to hope to explain this in a way that makes sense. Lots of moving parts here, Tim. Perhaps some day…

  7. Frank B.

    Great article, Ben.

    Funny timing–I actually had a dream about this last night about cash flow vs appreciation and came to the same conclusion as you lay out in your article. It’s almost like you communicated to me directly through my dream. Needless to say I’m going to the doctor to prevent this from happening again in the future!

    Really though, thanks for the article.

  8. I experienced this phenom by accident on very first real estate investment I made. I bought a duplex in a popular downtown area for 94,000, it cash flowed about 22% cash on cash. That’s really all I was thinking about when I bought it. Laughably at the time it didn’t appraise so I got a 3/1 arm that the bank kept in their portfolio and I had to put up a little extra cash to make the down payment. 3 years later I went to refi it because the ARM was going to reset, and it appraised at 116,000, it was a lightbulb moment for the type who has to learn by doing. I just got 22K richer without doing much of anything aside from managing this property.

    • Ben Leybovich

      You bought cash flow, but you backed into wealth. This time, Mike, it may have been on accident. But, going forward you will intentionally look only at those deals which have the potential of performing this way. Very, very few deals can do this, which is why truly good deals consistently are hard to find indeed 🙂

      Thanks so much for the comment!

    • Ben Leybovich

      I just checked my T7 financials and guess what – about 21% of my cash flow across the portfolio went out in CapEx. If it weren’t for high leverage which is being paid down by tenants and some forced appreciation which enabled me to take money off the table, I’d be hard-pressed to articulate why even bother owning property…

      Believe me, Jeremy, cash flow is a fickle thing. It’s here today, and gone tomorrow. You have to have a lot of it, and it needs to be highly diversified, or else…

  9. Alex Chin

    Hits the nail on the head for what I want to do with my investing career. I aim to buy small multifamily and increase income/decrease expenses, then sell in a few years having forced appreciation and expand the number of doors I own. If I can manage it, I really don’t ever want to have to deal with SFR except for the rare flip opportunity that slides my way.

    Leverage equity build-up and grow my portfolio to the point where I can truly utilize economies of scale and start to get more “hands-off” in the business. Ultimately, I want to be in a position to enjoy time with my family whenever I want, wherever I want, however I want.

  10. Tammy Vitale

    I liked this article. And I agreed with it. Because I am an accidental real estate entrepreneur and my principle and a little rental I bought back in the 90s funded my current aquisitions via equity (4 buy and hold in the last two years) once I found the right lender and listened hard to a gf who now owns 10 houses (she only owned 6 back when I started all this). That little rental? Probably the worst deal ever cash flow wise but it wasn’t an investment, it was a place to run away to that wound up being too close to home to run away to so we rented it after we fabulously rehabbed it (for ourselves). Cash flow? negligible but I didn’t buy it for an investment even tho it has turned into one (esp with a tenant that will literally be there for life). Equity? awesome. New purchases? 2 ready to go (right and the end of the downturn) and 2 rehabs in Florida before prices started moving upwards down there. Cash flow on all of these is good, the last one GREAT but by then I had the concept down. I didn’t know anything about 70% or 2% or 50%, I just knew: it costs this, it will cost this much to fix it up, this is what I can rent it for in a rising market, my tenants are buying these 4 houses for me. That made financial sense and so I did it. Arguably not the best business plan but it works.

    • Ben Leybovich

      Tou-che’, Katie. The value of IRR is not in that it’s a metric of return, but in that in order to calculate it requires us to tell a story of cash flows. In turn, investors can look at all of these events and assess whether our assumptions of what will happen, when, and how are reasonable and indeed probable.

      This is why we prefer to deal with accredited investors; people who possess a certain level of sophistication around these things. This is also why SEC guidelines relative to who can invest are rather strict.

      The “mathematical map” which ultimately culminates in IRR is only as good as an investor’s capacity to read it. But, at the end of the day, at least there is a map. When underwriting to other metrics, all of which are static, there is not even an option for investors to formulate opinions…

      Thanks indeed!

  11. Julie Macd

    Thanks for a great article. and timely too as I consider my real estate strategy and the balance between cash flow and appreciation. of course the whole reason I can consider my strategy is that my SFH, which has barely cash flowed, will most likely sell for an IRR of 100% after 4 years. Was I lucky or smart?

  12. Eric Blanchard on

    Thanks for another great article – it’s far too easy to get stuck analyzing “the deal” and forget to look at how it plays into the bigger picture of building wealth: cashflow buys time so you wait to exit until it’s strategic.

  13. Kariuki Kagombe

    @ Ben that was quite informative article, it is really amazing as I find it educative someone else thinks it has taken toll of his valuable asset, time. Please continue posting, out here am learning.. as well as getting entertained. Thank so much

  14. Clayton Rokosh

    As someone who’s just beginning with REI, I have to say, you’ve changed my perspective. Although I didn’t understand everything talked about, nor the terminology here and there, but what I did get the most out of is how cash flow is a temporary solution.

    I plan to learn and practice house hacking with multifamily homes and plex properties, but reading this blog post made me realize that living the ideal house hack, where my tenants pay for most or all of the expenses, to buy time for other investments. Hits the nail on the head!

    Now I don’t understand what equity or appreciation means yet, but all I know is that it’s important for building “wealth”.

    What does that mean though? In a comment somewhere above, you’ve said,”You bought cash flow, but you backed into wealth”. What is wealth and why is it different from cash flow? Why is having only cash flow similar to working a job forever? Is “financial freedom” not defined as cash flow > expenses, but actually it’s wealth > expenses?

    Sorry for all the questions, I truly feels like there’s SO MUCH I don’t know about REI.

    • Ben Leybovich

      Clayton – good questions! Here’s the chain of logic:

      – Financial freedom is defined by STABLE cash flow.
      – Stable, relative to CF in real estate is a function of quality of asset.
      – If asset possess enough quality features, then it will more than likely appreciate in price over time
      – You refinance or sell to put lumps of cash in your pocket with which to buy more CF
      – Rinse and repeat 🙂
      – Therefore, stable CF today by definition brings wealth tomorrow.

      Jump over to my site when you get a chance. I think there’s a lot of content there that you’ll find very beneficial in answering these questions

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