Cash Flow or Appreciation: What the numbers say

[Account Closed]

There are pages and pages of discussion and opinions on cash flow markets (midwest) vs. appreciation markets (coasts). What I haven't read so far is a simple analysis of the numbers. Since I actually own properties in both markets, here is how I see the numbers stack up. Now remember, this is only the numbers, not counting work, risk, hassle factor etc etc.

Lets consider two hypothetical but typical portfolios. Each is purchases with 25% down and 4% interest rates. The midwest property returns enough cash flow to pay off the mortgage fully in 10 years if all positive cash is reinvested into principle reduction. This is possible and I am doing it on my midwest portfolio.

The coast property lets assume just breaks even even after paying the mortgage on a 30 year basis. Thats common with many coastal expensive markets and probably the lowest return I would accept as I don't want to have negative cash flow ever.

Lets assume we sell both portfolios after 10 years

On the midwest property lets assume 0 appreciation. Your total return over 10 years would be 300%.

If the coastal property would grow at a CAGR of 5% per year, after 10 years your gain would be slightly higher than this at 322%. If it grew at 4% per year it would be slightly less at 265%. So you would need something between 4% to 5% CAGR over 10 years for both these investments to have equal returns.

These are rough numbers, no closing costs etc accounted but I think it makes the point. 

So then you look at the risks on either case. Both have risks. Cash flow may not actually be as high as you thought and reduce returns. OTOH, appreciation may also not happen.

On the plus on the cash flow, at least some of it is in my control. The appreciation is a market phenomenon and mostly out of control.  And cash flow is independent of value of the asset. It can go down but the cash flow remains. Also equity builds fast and chances of getting upside down is low.

On the plus side of appreciation: Chances are its a lower time commitment and better tenants. Plus it has a better upside. The cash flow is bounded and you can only improve it so much. Appreciation upside is theoretically unlimited. But equity builds slowly and you could end up upside down in a bad market.

So I guess the point is there are pros and cons to both approaches.

[Jay Y.]

@Account Closed Something interesting I've observed, and maybe you've witnessed the same thing yourself:

In the Midwest, my properties all experienced the highest CoC returns in Year 1. Over time, maintenance repairs started to become more of a factor, and the rents don't scale nearly quick enough to offset those added expenses.

In the Bay Area, vacancy has been 0% and maintenance... I think I've spent $5 total in the last 2 years on a single bottle of Drano. I've heard from others (as well as from my own experience), many tenants will service minor repair items themselves b/c they don't want to disturb the landlord... Why not? It's a TOTAL seller's market right now and every tenant's biggest fear is an increase in rent!

I'm not saying that the above will always hold true... It more just illustrates what a perfect storm we've got going on in the Bay Area right now. Well, over the last few years... Tech is exploding again... Appreciation, cash flow, low vacancy, low maintenance, easy exit strategy, wonderful location (good schools + lots of jobs), perfect weather... What more could an investor possibly be looking for?

I'm an engineer, but I've learned not to be a numbers guy... If you fixate too much on the math, you might miss out on some "once in a lifetime" opportunities!