Cash Flow Isn’t Everything: How to Incorporate Appreciation for Maximum Wealth-Building

by | BiggerPockets.com

Whether you’re new to investing or you’re a seasoned real estate investor, there are really two ways to build a real estate portfolio that helps you attain financial freedom or stability. One is by investing for cash flow and the other is through appreciation (or the asset’s potential increase in value). While some investors may prefer one of these strategies, others try to incorporate both.

For many years, I thought buying properties that cash flowed was the only way to go, especially since that extra cash helped to cover the cost of repairs and rising taxes.

More recently, covering the cost of rental licenses and inspections has become a consideration as well.

Some towns where I’ve been investing in for the last 30 years not only charge inspection fees but also re-inspection fees, and now they want everyone to be licensed and to carry permits. It’s gotten so bad that our property management company is starting to charge for inspections due to how time-consuming and burdensome they are.

As for me and my long time real estate investor buddies, sometimes we discuss the recent chain of events over the last few years, and the idea of investing in cash flowing properties as a buy-and-hold strategy no longer seems as appealing as it once was back in 1989 when I first started.

Back then, if you had a problem tenant, you could actually call the township and they would help you get them out. Today, things have really changed. Not too long ago, I called the township to report an abandoned car in the alley behind my property, and the next thing you know, the township was fining me for the abandoned car.

landlord-lessons

Related: Why You Should Only Focus on Cash Flow (Not Profit) Each Month

But as my investor buddies (with 100+ properties each) have pointed out lately, if it wasn’t for their flips, they wouldn’t be making much money. When using the buy-and-hold strategy, with its increasing property taxes, wear and tear, and constant turnover, they’re lucky if they break even. Keep in mind, these were places that usually always cash flowed at least $300 a month and were blue-collar, 2 and 3-bedroom homes that were under $100,000 outside of Philadelphia.

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So, What’s an Investor to Do?

Most of you know my story, that I was on the path to own 100 properties too, but I stopped at 40 places and moved more into the note and private money space. Today, I still have 19 buy-and-hold properties, and it’s getting tougher and tougher to deal with all of the challenges. Some of the areas that were once cash flowing great aren’t in the greatest neighborhoods or have the best clientele anymore, and to be quite honest, they really haven’t appreciated all that well.

In the last uptick, I was fortunate to be able to consolidate some, but now my strategy is a mix between further consolidation and paying down on the debt in order to cash flow more as I approach retirement. As all of this is happening, I’m starting to realize that cash flow isn’t always everything. If the area changes, the properties become more obsolete and the cash flow may not be what it once was.

Investing for Appreciation

Today, as a higher income earner, cash flow isn’t my only consideration. I’m willing to consider less yield, as I don’t really need more income. I also like nicer properties in better areas with some chance of appreciation, even if they don’t cash flow quite as much. If I can get newer places with better schools, I can attract better tenants, and with more demand, I can keep raising rents. I may also see more significant appreciation in the surrounding counties with more jobs and economic growth.

Today, I invest more for capital gains than for just income. As I mentioned, though, this wasn’t always the case.

If you’re not a high income earner and you’re just starting out in investing, it’s probably more prudent to invest in real estate for cash flow (to add income streams and to protect yourself from the asset’s possible loss in value). Of course, this decision should really be guided by your investing goals.

The ultimate goal, in my mind, would be to incorporate both into your real estate portfolio. That way, your cash flowing assets can offset the properties that don’t bring in that much cash flow.

If you are investing in a property for the potential appreciation, another way to increase your cash flow on the deal may be to tap into the available equity.

tax-changes

Tapping the Equity

The one strategy I’ve employed lately in the nicer properties I have that have appreciated is to tap into the equity with a home equity line of credit (or HELOC) with a low rate, and then either lend the money out to rehabbers with 13-18% returns or to invest the money in performing notes. The spread I’ve created through this arbitrage model has more than offset the lower cash flow I once had and has made these properties the gems in my portfolio.

So, which strategies are you using to add gems to your portfolio — investing for cash flow, appreciation, or both?

Let’s talk in the comments section below!

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for over 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

15 Comments

  1. Tyler Wade

    Great article, appreciate the look at the other side of the coin, as 95% of advice on this site revolves around “invest for cash flow, appreciation is icing on the cake”. In my limited experience (3 properties), I have invested for appreciation, and only purchased at lower points in the market. I think that investing for cash flow in times like these, when the market is high, makes sense, while investing in historically desirable markets when the overall economy is cool is a great strategy. I recognize there are definitely other strategies, but this is the approach that’s worked best for me.

  2. Curt Smith

    I agree that too little is written about buy and hold beyond cap rate!! My partner (wife and head strategist) and I have bought, rehabbed, loaded and now self manage 35 SFRs in the past 6 yrs. Thanks to the excellent strategy we have used for determining where to buy, what to buy and then how to market our portfolio can be described as:

    – low management effort. A few hours a month for me, and a few for my partner who keeps track of the rent.

    – High appreciation. Because of our business rules: buy in good high school districts, great schools 6 or better, AND in the path of jobs growth. Not just existing good jobs, but GROWING jobs. No PHD needed to guess this is a great formula for ever increasing buy side demand for houses floating our resale value of our rentals in the process.

    – Low turn over. Families with kids tend to say for 5 yrs or more while all kids flow through the school system.

    We didn’t target appreciation specifically but we did target low management effort, low turn over, high rent and appreciation came along for free (or vs versa).

    Further, in order to pull 35 deals out of a hot market in 6 yrs AND keep our cap rate well above 15% and get all the above benefits we had to get even smarter than even the above.

    – We moved to smaller markets where there are few investors competing for rental housing stock. We live in Atlanta a red hot market, zillow’s “neighborhood” heat indicator is red for most of metro atlanta. We moved to smaller towns where the zillow neighborhood indicator is blue, cold AND all of the above criteria.

    Add in:

    – 10 minutes to a major freeway, 30 minutes to a major jobs source.

    – cute look, 3+bed, 2+bath, in a family neighborhood.

    And you have a set of business rules that will net you a great rental portfolio. I know what you’re thinking,,, but the more I’ve listed to Tony Robins and other success speakers and then put it into practice, if you don’t set the rules you won’t accomplish them! Give it a try, your areas will have variables you’ll need to work with.

    Your to dos are:

    – find the great schools 6 or better areas on the map.
    – find the cheapest neighborhoods in those areas.
    – where are NEW jobs going? Find your states PR website and search periodically for new jobs. IE georgia.gov
    – use: maps.google.com search: -your state name – amazon distribution center
    Amazon is now a great indicator of where growth is at. Plus those distribution centers employ a lot of folks all renter income, not buyer level of income.
    – use indeed.com putting in local small town names set 5 mi radius. Punch in a dozen towns of approx same size and map out where more jobs are at for the same population. Combine this with new job announcements.

    You’ll have great appreciation using some or all of the above. Good luck.

    • Neema Nene

      Thank you for this article Dave. We have purchased rental properties and currently have 14 with a unit count of 64 in 3 years(2012-2015). We are starting on the second phase of buying soon and are trying to learn from our ‘stumble and learn’ strategies of the past and reading this article really helped to solidify what we need to do which is to create the roadmap/goal and have criteria that suit us and go for it! I’ve looked at notes too but don’t know enough to make a decision yet.
      Great to talk to like minded people!

  3. John Barnette

    Agreed. And I feel there are times that may be more opportune to move between market types and property types. I have a smaller portfolio of sfr’s and condo’s in two SF Bay area markets. Half in an improving somewhat trendy neighborhood in the city. Purchased several distressed properties or from motivated owners. And half in much more affordable properties in working class communities of Richmond and San Pablo. Reasonable access to freeways and train system. Although not really a commutable distance to silicon valley. Not distress except 1. Getting cash flow and some appreciation. Great balance. And in this expensive market i just traded up from a SF condo appreciation play to a blue collar neighborhood 8 unit cash flow play…with appreciation potential via pretty consistently increasing rents at a slower and steady pace compared to the extreme boom and fizz of SF proper. When SF is in correction again…I will look to pick up more appreciation oriented assets.

  4. Rick Santasiere

    Great article Dave. Thank you so much for sharing your insight on the two styles. The blended mix is always great. Cash flow is always king for me, however, I am more conservative in my buy and holds and stay in Class A areas, where I feel that chances for appreciation are higher (although we are talking about CT – where job growth is not as strong as some hot areas in the states, and people are leaving at a higher clip than arriving) I also buy for two other reasons, although I love yours. I buy homes that I would live in myself. I also buy homes that a first time home buyer would buy if I needed to liquidate sooner than later. Buying the “odd house” for greater cash flow, but decreasing appreciation and less chance of disposing sooner, is not favorable for the type of REI I am. I am a firm believer in buying REI with multiple ways to get rid of it (or keep it): Rent, Sell, lease option (they all have to be options for the home), or Rehab, Rent/lease option/re-finanance/rent, flip/buy hold. I think that REI’s who only seek out one exit strategy (or hold strategy) is a mistake, and the more it happens, the greater the chance of losses.

  5. Harrisson Dawson on

    I totally agree and resonate with this article. Every single habit presented here is very important, in my opinion. Investing is scary at first, that\’s true, but you have to \”risk it\” for the \”biscuit\” if you want to make 6 figures. One of the most important skills to have, in my opinion, is learning how to \”read the company\’. For example, the enterprise value of a company http://investingpr.com/enterprise-value/ can tell you a lot about it, you can see if the company is healthy or not, develop an impression about it, and decide if it\’s worth investing or not in it. Remember, investing is not a gamble!

  6. Nick Tiedt

    Feel free to give as much or as little info as you want…but at what point does lending money to rehabbers become possible? Having $XX amount set aside? Having friends/connections constantly looking for hard money?

    Looking to start buying sfr and small multi’s within a year, so this doesn’t apply to me, just kind of curious.

    Thanks!

    • Dave Van Horn

      Hi Nick,

      All good questions. Obviously a lot depends how much money the deal would require (which could vary based on your market) but the lowest end I’ve seen was around $30K or $40K for hard money loans. Some people will do private 2nd mortgages for as low as $20K to $25K though.

      Keep in mind though, that not all of your money you lend has to come from you directly. I used to think that and it limited me in how many deals I could do.

      Best,
      Dave

  7. Christopher Smith

    Interesting article.

    Kind of a DeJa Vu moment all over again for me.

    I bought heavily into the middle and upper middle income neighborhoods in the far east SF bay area between 2011 and 2013. Prices were so depressed then (low as .35 on the dollar) that you even got a reasonable cash flow yield. Not truly great, but very respectable. But the underlying appreciation has been absolutely incredible on these properties. Most everything has increased over 100% in the SF Bay area during this time period. I’m thinking things will start to cool (they almost have to), but due to tax and transnational cost concerns I won’t be selling. Rent on FMV now is truly terrible for new investments, so I won’t be buying anymore out here, but my solace is that rent (which has also risen a lot during that time) is still quite good based upon my original cost and I can live with that.

    My last few buys have actually been in Ohio where cash flow is still quite strong at least in some areas. Same overall strategy in there, middle and upper middle income neighborhoods. These won’t be the super high octane price appreciators that the California properties have been, but I’ve chosen Nerd Wallet’s number #1 pick of Ohio cities to buy in for growth, so there will still be some underlying appreciation. Last one I picked has already increased by about 17% since I picked it up in June (some of that was probably attributable to getting it slightly below market). That is not likely to continue I am sure, but the neighborhoods are so nice in that little niche area that I am confident they will do well even if Ohio ends up being somewhat of a laggard. I lived in that spot before moving to Ca, and I already had the infrastructure in place (prop mgr, agent, ins guy, etc) so it worked out really well.

    This mixed strategy gives me a reasonably well diversified portfolio of rental properties. Some very high appreciators with modest cash flow, and some high cash flow with more modest appreciation potential. These are my two criteria.

    1) Strong Cash Flow with at least some modest appreciation potential, or
    2) Strong appreciation with acceptable cash flow

    Tough to reliably find either in today’s market, but I did manage to hook one earlier this year in the first category. Wish I were back in 2011-2013, in the Ca market it was like shooting fish in a barrel, now its like finding a needle in a haystack.

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