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

by | BiggerPockets.com

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.

tax-changes

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.

80 Comments

    • 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.

    • Jason Lewis

      I disagree with your comment about the “stabilization” not being included in the IRR. It is absolutely included in the IRR. I would argue that the stabilization is the biggest driver of my IRR because of the value add that it provides.

      So everything from construction costs to holding costs are inputted into that equation.

  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

  15. Eric Jones

    TOTALLY agree with this article. I work as a financial analyst and I ALWAYS look primarily at the IRR. I still care about CoC ROI and cap rates, but at the end of the day, the IRR should be the best reflection of an investment’s impact on my net worth.

    Due to the time value of money, high velocity money (either cash flow or equity) will boost IRR since the values will be discounted less. My question is, how do you estimate the terminal value of a property when you sell it? Do you have a plan up front to increase the NOI, then implement it, and derive your new valuation by dividing the new NOI by the cap rate? I’m trying to apply this concept to 2-4 unit properties, but the valuation doesn’t seem to be purely based on income (as is the case with apartments). So I estimate terminal value of a property based on an estimated appreciation rate. There are many assumptions that need to be made with IRR (length of time, terminal value, estimated cash flows and costs over time), but I agree, it is the single best metric for an investment’s performance.

    • Ben Leybovich

      Eric – thanks for reading, To answer your questions:

      Terminal value – you’ve got it. Since the market (not us, but the market) will be pricing a capitalized value relative to the historical/in-place NOI, we can indeed have a plan as to how we’ll be driving the NOI. The unknown is the Cap Rate, which is why when formulating the exit it likely pays to escalate income/expense, but also take a realistic view of the future Cap Rate, and discount the latter as need be.

      To your second question – this doesn’t quite work at the small multi level. Why – because the buyer is different, the appraising mechanics are different, and the lending guidelines are different. In other words, if you are wise enough to look at the exit before you buy, then you must identify who your buyer will be, and what drives their bus. You’ll find that people in the small stuff are much more apt to look at price/door than anything to do with capitalized value…they are just not sophisticated enough. Therefore, even if you are able to justify capitalized value, you are often limited on this logic.

      Makes sense?

  16. Jim T.

    Thanks Ben for the article. There are indeed differences. I am in California and out here, we generally think in terms of appreciation. You cannot buy rentals with the 2% rule in coastal California, they just don’t exist.
    [In CA, no one uses the expression 2% rule, they use GRM. 2% rule is a GRM a shade over 4, in coastal CA, a GRM less than 15 starts to look good, less than 12 is a steal]

    One thing I will add is taxes. Taxes on income are taxed as ordinary income. Taxes on appreciation are taxed as capital gains. Also, capital gains taxes are deferred until you actually sell. Paying taxes each year removes capital from compounding. This can be very expensive. You do have depreciation here to help

    Now that I have had the rentals for a while (I bought them when they were on sale between 2009 and 2011) the GRM to original purchase price is under 10 with a cap rate over 7%. Remember, I bought these for appreciation, not income. I am using some of the income for upgrades, those upgrades that translate as close to 100% of extra (eventual) appreciation.

    Point I am trying to make, even in appreciation markets, eventually they are income markets too as rent prices keep rising. There was an exceptional buying opportunity a few years ago that accelerated this in California.

  17. John Murray

    Great article Ben. I live and invest in Portland Oregon. The market is hot and I own 7 single family homes and will have 10 buy the close of 2017. Appreciation and positive cash flow are symbiotic in my strategy. My initial investment was about $500K. I buy 20-30% under market and renovate myself in usually 30-days. My down payment is 20-25% depending on lender. I refinance as soon as I can clear $50K in appreciation. My first three I refinanced and extracted $152K in October 2106. I reclaim at least 10% of my initial investment in the first year thru rent profit. My net gain per year is about $250K.

  18. Mike Dymski

    “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.”

    Well said. Force appreciation and you don’t have to decide between the two.

  19. Mike White

    Do we have to be in one camp or the other? I like cash flow because when it increases then I increase my monthly payment on the loan, which decreases the amount of interest I’ll pay over the life of the loan, and of course shortens the loan, which all increase my equity regardless of appreciation. But the real increase in the value of the asset seems to be appreciation so gotta love that too!

  20. Rick Boothby

    Interesting article. But I see this very differently. My point of view may be mostly a function of where I live though. Appreciation is nice, if it ever happens. But what if appreciation in your market is historically 0% or 1% or 2% a year? 3% would be a regular miracle in the Mid-Ohio Valley. And what if your journey towards building appreciation ended around 2007? Pretty frightening. When supply and demand are driven by factors far beyond our control—like unscrupulous bankers and asleep-at-the-switch ratings agencies—I am not sure that counting on appreciation is the wisest course.

    Cash flow is much more predictable. If you buy the property right (and when I say “buy” I mean with leverage up to 80% LTV), and you have done your homework, you will be fine, With solid cash flow month in and month out, you will have a robust capital repair fund, worry little about changes in taxes and insurance and basically can “set it and forget it.” On the other hand, if you are pinning your hopes on appreciation that may never come and having to put your own money into a building just to break even month after month, I think your nerves will eventually reduce your capacity for expanding your business.

    As far as building equity goes (really a different subject than cash flow vs. appreciation) you make your money on rental properties the day you buy them. That is perhaps the most important thing I have learned and found to be an immutable truth.

  21. Paul Merriwether

    Nice article Ben, yet you and others are looking at real estate from one perspective, being that cash flow is always positive. What about negative cash-flow? I mean who wants that … right!!! You wrote >>You refinance or sell to put lumps of cash in your pocket with which to buy more CF<< I live in Oakland, CA. I never ever had positive cash flow from any of the SFR's I've owned from the very first rental property SFR bought in 1980 for $50,000. Depreciation, neg cash flow on rents, expenses, greatly reduced my over-all tax liability. It was sort of like investing in stocks, hoping they'll go up in value. Well property did APPRECIATE!!!

    I'm not up on all the terminology you guys are using, out here it's buy and hold on for MASSIVE APPRECIATION!!! Appreciation is the key. If a property won't appreciate much over time, the question is how can I improve or upgrade so I can get that appreciation in equity in a short amount of time thus your buy & flips.

    Looking back over 56 yr's in our area SFR have appreciated approx 3% – 8% on avg annually. That includes property in the very worst areas of Oakland (a high crime city). So what does that mean … a $10,000 3 bd 1 bth ranch home in 1950 with an appreciation rate of avg 5.5% annually over 66 yr's is now worth approx $377,000 (a so – so area now) according to Zillow. That was the price my parents paid for that home. They bought another one for $20k in 1960 which is now valued at $1.2 million over 56 yr's. You are correct appreciation is what all investors should be looking for! IMO that happens more in SFR than in muliti-family units which produce cash-flow!!!

      • Paul Merriwether

        According to an inflation calculator a home purchased for $20,000 in 1960 in Oakland would now cost in 2017 $164,000, Cumulative rate of inflation: 720.04% . Lets look at it another way. My first car a GTO in 1966 cost me approx $3500. In today’s world a similar car would cost approx $35,000. That equates to 10 times. The home at $20,000 x 10 = $200,000. That car cost would be the same in any part of America. Yet the home price wouldn’t be. Location, location, location comes in to play.

  22. Kelvin Lee

    My take away of this article is never solely rely on either cash flow, appreciation or IRR to gauge your performance. Having a constant COC every year doesn’t represent the equity has been working hard as it should be during the 5 years period. There could be other investment opportunity out there you missed out which could generate even greater return. By speculating the appreciation but ignoring cash flow is senseless either. Cash flow, as this article mentioned, is to keep your wealth and equity afloat. Always have an exist strategy in mind before buying a property. Gauge your performance with NOI while looking out for a better opportunity in the holding period. More importantly, invest on property that has great equity value for cash out refi. or exchange. Create the financial flexibility to get yourself ready when opportunity arise.

  23. Cathy Lippert

    I have a beginners luck story too. Bought single family residence in 1990. Turned it into a rental in 1999, and it has netted $15k/yr pretty much every year since. Not a super return on investment, but positive cash none the less. Purchase price was $224k, but recent comps are in the $700K+ range. It took a while to triple in value in a famously hot east coast market, but the waiting will pay off. My investor friends scold me for not trading this property in for 4 others here in northeast Ohio, where I now reside. I think I’m doing better by keeping this one, with more appreciation, and avoiding 4 times the capex. (I’ve recently invested in 2 Ohio properties also, where very little appreciates unless you buy right and improve the value. I’ll let you know how those turn out later. I can predict that they won’t build wealth like the first one, but then again, I may be able to retire on the income.)

  24. Peter Mckernan

    Hey Ben,

    This is a great article! Thinking about making sure that cash flow is created day one, and not a negative is always good. This cash flow CCR gets the investor (you) to that end game while building that appreciation throughout the holding period to create the wealth that is looked for in properties. This also gives other advantages and options to those investors to make different moves.

    I agree with your article a whole lot, the aspect of only looking at one or the other is incorrect; however, we have to make sure that just one fixed approach can burn an investor. Keep a mindset that is open, educated, and continually growing while investing to make sure those huge misses are not a game ender.

  25. Great food for thought, Ben. My addition to those interested is to say that at the ripe old age of 50, my perspective has changed over time. My wife and I built our net worth with leverage in younger years, but have converted leverage to cash flow in later years. We believe finding the right balance of each for life’s needs and wants over our lifespan is the real art of this business. And, this applies to other forms of investing, too. Thanks for sharing your perspective!

  26. Brandon Pfannenstiel on

    Do you ever hold on to properties simply for cashflow? I only ask because I know of a few turnkeys in St Louis that are not going to make me rich by any means but will supplement some liability expenditures

    • There are some REI that assign an arbitrary number for their holding period. This arbitrary number is meaningless without some qualitative consideration; for example, fluctuating market values, cost to maintain property, taxes, insurance, rent, interest rates on loans, property appreciation, IRR, etc.…. There is an amalgamation of factors to consider relative to one’s holding period. It’s good to have an exit strategy going in but market conditions may move that number up or down. I’ve seen people hang on to a property for the cash flow at the expense of maintaining the property in good condition. Yes, they made a little money on cash flow, but ultimately lost money when the property was sold.

        • Congratulations! I didn’t start until age 32, so you are way ahead of most in terms of your age and desire to learn. Keep studying, make smart decisions and the 60-year-old Brandon will appreciate your efforts.

    • Paul Merriwether

      You can create your own appreciation. EX: two homes identical in 1980. Yet in 1990 one owner adds on to his 2 bd, 1 bth 1000 sqft home making it a 4 bd, 2 bth 2000 sqft home. Over the next 20 yr’s both homes appreciate. That 4bd, 2 bth is now worth $600,000, and the 2 bd, 1 bth $400,000. You come along and purchase the 2 bd, 1 bth. Other neighbors have also added on to their homes making them 4 bd, 2 bths. Because the larger homes are worth $300/sqft you only need to keep add-on costs to $100/sqft DIY work. Your potential profit is $200/sqft or $200,000 for the new addition. This is the reality of homes in many high pried areas. Why bother with rentals & cashflow when you can locate smaller homes is appreciating areas that lend themselves to this type of appreciation???

      • Paul Merriwether

        I’m sorry potential profit is $100,000. Since you spent $100,000 to add on 1000 sqft. The point is you can control your profit and create appreciation. My parents home was on a down hill lot. Two floors were finished. Leaving the second floor which was under the first floor you step on to a slope that led to a back door which was 20 feet below the second floor. Thinking back to that home. It would have been very easy to add a third level of at least 600 sqft ( 20 x 30). At $300/sqft there’s another $180,000 – costs just for adding a floor!!! The walls and foundation were already in place.

  27. Hyacinth Dolor

    Very good article Ben. A very different way to see investing.
    I enjoy buying and fixing on the side. I recently quit my 9-5 and now part time realtor, part time landlord. I’m a full time stay home dad (3rd baby on way) and plan on going full time flipping in 1year. (Finance is good with family)
    I bought a 3 fam 7 years ago for 155k and currently owes 130k. I was offered $250k for it and is reconsidering keeping due to $1000 month cash flow and want this property to be for third kid. Although I may be able to make more money flipping I think I’ll be worth much more to keep since I won’t be the one working to pay off. It is also in a good area and maintenance I truely enjoy. What would you do if you had that many options and $150 equity on all 3 properties?

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