Comparing real estate opportunities (cash flow vs appreciation)

[Ryan McDaniel]

I'm currently evaluating several different properties and need to purchase 2 prior to the close of the tax year. Some have very high appreciation potential with less cash flow while others have great cash flow and far less appreciation potential due to their location, age, etc.

My overall goals are to use these for retirement and pay them off no later than 15 yrs from now. I'm not interested in immediate cash flow specifically but rather the overall investment yield over 15yrs including net cash & appreciation.

Any recommendations on how to generate an accurate comparison? It seems i'd need an estimated appreciation percent, adjustment for inflation, etc.

[Jon Holdman]

Mostly what I'm saying is that its hard to predict the future. When you make guesses about the future, you can fool yourself about a deal by making minor changes in your guesses. Its much easier to understand the situation as it is right now.

In theory, rents should rise over time, expenses should rise and values should rise. Meanwhile, your payment (assuming fixed rate long term financing) stays the same. So, your cash flow improves. In reality who knows what will happen.

I wouldn't discount appreciation completely. I do not think we will ever again in our lifetimes see the kind of appreciation we saw during the bubble. But a few percent per year is certainly possible. I'm just not convinced we're at the bottom, yet. Macroeconomic events will affect us, and we have no control over those. Another 10% decline will take several years of 3% appreciation to make up. If I were to guess about the value of a property five years from now, I'd guess the same value as today. For 30 years out, though, I wouldn't even hazard a guess.

Whether or not equity is significant to you depends on your strategy. If your play is to buy and hold forever (leaving the properties to your heirs) and you want cash flow, then equity doesn't really matter. You're not going to get that cash. If your strategy is to hold for a while then sell, then equity does matter. Or, if you're planning to refi at some point and take some cash, then equity does matter.

In commercial deals, a "total return" calculation is often done that accounts for principal paydown. Problem is you can't eat equity. Whether you sell or refinance its expensive to turn equity into usable cash.