Cash Flow or Capital Gains?

Question

As a newbie investor, I’m conflicted between cash flow vs appreciation potential, especially in a market where everyone wants the highest price and deals are harder to find.

If the cash flow numbers make sense, does it matter if you might pay top dollar for a property in the 2021 market? Once market supply goes up... what if I paid too much... The cash flow is still there, but am I missing the big picture?

Curious on your thoughts, thanks!

Antonio Cucciniello · Answer

@Ethan Brown This is something that really got me when I started. I was like I want cash flow for passive income, but I also need appreciation cause what happens if the home value drops!

But then I realized, if the day I buy it, it cash flows, and let's say there was a market crash the day after, that is ok. I mean it sucks that I won't have extra equity in a property, but really it does not affect my cash flow. I am still making cash flow.

Let's look at the other scenario. You buy a house solely for appreciation. It does not cash flow, and instead it costs you $200 dollars a month to cover bills since the rent.

But the home increases 10% over the next 2 years. So you gained some equity. You will only get that money if you sell, and then you still need to pay taxes on that (unless you 1031).

In one case, you have cash flow no matter what and you have to just wait out the drop, the other, you need to pay a bill every month until you sell for some profit down the line.

Greg Williamson · Answer

@Ethan Brown I think you always want to have a property that cash flows because if the market falls, you can wait for it to recover with no real impact to you in the here and now.  However, I think focusing only on cash flow is also a mistake.  I evaluate my properties based on not only the monthly cash flow but also total accretive value added.

That means I want to know how much equity I gain every month by paying down the mortgage as well as how much appreciation I expect to have.  I think the real money is made through the equity you are building and not the cash flow.  A real world example for me is a property that cash flows $285/month but is gaining $570/month in principal payments on the loan and $900/month in estimated appreciation (3%/yr).  In this example, if you got hung up on the cash flow and chose to walk away from it at $100/month cash flow you would be leaving the $1500/month on the table.

I think there is logic in buying the most expensive property you can that has positive cash flow because you will maximize items 2 & 3 of the equation above.  Of course, I'm not suggesting you overpay for properties, just get deals in more expensive neighborhoods.

I also BRRRR into my deals so the one I sketched out above has an ROI of ~42% if I just consider the monthly cash flow or ~260% if I take equity and appreciation into account.

If you have a cash flowing deal, go for it.  I don't remember the exact quote from Scott McGillivray in his BP podcast but it was something to the effect of "If you find a deal that cash flows, buy that one and buy the next one.  Buy them all!"  Good luck and get going.

Brian G. · Answer

@Ethan Brown often people seek more cash flow markets early on in their investing (ie to be able to quit their 9-5 job and transition to REI “full time”) and appreciation markets later on (where big money can be made and depreciation can offset high cash flowing investments). Those that don’t need money from REI to live on any time soon and don’t have a goal to quit their job may prefer to seek an appreciation market right from the start. It all depends on your goals, market you invest in, skill set, overall financial position, etc. In an ideal world you purchase properties that cash flow initially AND appreciate in value and in rental prices over time. Not easy to do. Good luck!

Johnny D. · Answer

@Ethan Brown

I definitely agree you make money when you buy, but this extra money matters a whole lot more depending on what your goal is and how long you plan to hold on to the property.  If you are trying to flip a property or BRRRR a property, obviously the price point is far, far more important.

If your goal is long-term buy and hold, the purchase price is still important, but it has to be considered alongside the opportunity cost of the time you wait to find a bargain.  The combined monthly principal and interest savings of purchasing a property for $10k less equates to $45 per month for a 30 year mortgage at a 3.5% interest rate which would total $540 per year ($486 if using a property manager).  You should have no problem finding a starter house that cashflows at least $300 per month, meaning you'd make more cashflow in the first year with a property that costs $10k more so long as it would have taken an extra two months or more to have found the bargain property.

However, who knows how long the inventory will be replenished again to allow more bargain opportunities.  It could be six months or over a year from now, and each month you wait you are losing out on the opportunity cost of a property that cashflows now.

However, I absolutely understand the desire to still seek the hidden gem, and I don't doubt there are still great bargains available even now if you look hard enough.

Ethan Brown · Answer

@Johnny D. Thank you so much for your thoughts, this helps! I do plan on buying and holding. My concern is finding a “good deal” (buying under market value) in 2021, but it seems to me that if the cash flow is great, I shouldn’t hesitate to start my investing this year. I keep hearing that you make your money when you buy though...

I don’t want to wait in hopes of finding foreclosures everywhere (who knows when that will be) for a bargain if my purchase power is diminished with inflation.

Do you agree? Let me know if you have any other advice, thanks again!

Mason Hickman · Answer

@Ethan Brown

$200/month on a single family or $100/unit/month on a multi. If you're really bullish on the market's long term outlook and/or current rents are way below market, I would accept a lower going-in cash flow (that is still positive) with the anticipation of raising rents at the next lease renewal.

Ethan Brown · Answer

@Mason Hickman thank you for your reply! I appreciate your feedback. If you don’t mind me asking, how much cash flow per unit do you try to aim for? I’ve seen $200 per unit is a good number, but I’m curious what others think.

Zachary Beach · Answer

@Ethan Brown it doesn’t have to be one or the other. Return is a function of VALUE ADD. 20+% for both return on equity as cashflow and high appreciation (20+% this year) are possible. Ask me how I know.

Mason Hickman · Answer

@Ethan Brown

If the cash flow works and you believe in the local market long-term, go for it. It’s tough to predict where the market will go short to medium term but if you have cash flow, it will allow you to hold on for the long term to see appreciation.

Ethan Brown · Answer

@Dmitriy Fomichenko thank you! Happy to be here!

Cash Flow or Capital Gains?

Most Popular Reply