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Updated about 6 years ago, 11/17/2018
Are you willing to invest in RE appreciation with 2 caveats?
The context being today's market.
Assumption: the new asset would be in addition to your existing positive cash flowing portfolio.
Requirement: the new asset’s cashflow cannot be negative. It must at least break even at zero - meaning the property is paying for its own expenses leaving you with zero cash flow/profits.
Premise: future payout makes it worthwhile to forego current positive cashflow.
Thoughts?
#2 General Landlording & Rental Properties Contributor
No. Speculation on appreciation does not fit my investing for income business needs. In most markets speculation on appreciation is way too risky.
With no guarantee of future pay out having no expectation of income does not make it a worthwhile investment. This approach is best left to those that specialisation in faith investing.
Originally posted by @Thomas S.:
No. Speculation on appreciation does not fit my investing for income business needs. In most markets speculation on appreciation is way too risky.
With no guarantee of future pay out having no expectation of income does not make it a worthwhile investment. This approach is best left to those that specialisation in faith investing.
Thomas, I agree to an extent. However, just for the sake of fleshing this out a bit more I’ll offer this. The initial zero-sum cashflow (at the time of purchase) will increase over time (2-3 years) as the rent increases resulting in a future positive cashflow. And, since home values historically increase in value (4-5%) then I’m going to gain on that side as well.
I agree with your comments, but if we view it as "speculative" then it creates a barrier rather than looking as the idea as part of a carefully considered strategy that's willing to include a break-even investment for the time being. Granted, I'm not proposing this for all markets. I bought a SFH in 2015 in my target market for $206K. Today its worth $280K.
I share the challenge many REIs currently face concerning these higher purchase prices that limit our willingness to invest – zero cashflow being a primary issue. But if we’re willing to make the investment – not as a loss – but at an initial zero-sum gain then I feel its worthwhile to consider.
Your thoughts?
Im going to purchase 2 properties within the next 6 months that will be about break even.
- Russell Brazil
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@Matthew McNeil It can be risky.
Just because your cashflow isn't negative doesn't mean you can't have other issues that will make your investment negative. If your roof starts to leak, AC breaks down, etc., you'll have to deal with expensive repairs while hoping your home's appreciation will come out positive.
If the market corrects and you have to hold on to the property longer, you could be losing money from having to handle repairs while you wait for the home price to go up.
Forced appreciation through rehab is your way to minimize these unexpected costs, not speculative appreciation.
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Some of my best IRRs after all was said and done were break-even during the hold. They broke even with 10% down. Sometimes break even was a choice because I was after equity capture and put them on 15yr mortgages. In 2012 15s had 30% lower interest rates than 30s.
But I purchased mine off-market, below FMV from tired landlords or homeowners with a problem they needed help solving.
Are you paying retail? That would put me in the no camp. We are still investors. Paying retail without cashflow, only hoping for market appreciation is more speculating than investing.
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@Matthew McNeil I am a buy and hold MF investor, so I won't buy properties that do not cash flow on day one. An exception might be an empty apartment building that can be readied within a few months for a reasonable amount-100k or so. If you get cash flow you rarely get appreciation and vice versa. Most often appreciation is a matter of where we are in the market cycle, buying now I would expect no appreciation -certainly not for many years. Your goals, market and expectations may be completely different, and that is just one of the many reasons why this business is so great. All the best!
I would add to your requirements that the Investor does NOT need the cash flow.
If they need the cash flow, then this will NOT work for them.
This narrows down the kind of Investor that should follow this strategy.
The only added Caveat I would say is that I include your JOB as a cash flow.
So if you are making a lot of money in your profession, then how is an extra $100 per month or even $1k per month going to somehow help you?
In my case, when I started out in 1997 in Brooklyn, NYC, I didn't buy for Cash Flow because that Cash Flow was just wasn't NOT needed. My Salary rose from an Entry level programmer of $32k in 1997 to well over $100k by the year 2000.
What also helped was that I lived below my means.
Combining having a good paying profession and living below my means, it allowed me to pursue Investments with Disposable money. That's actually the wisest way to invest. Invest with money you DON'T need.
This helped me to make over $10 Million in unrealized Appreciation for my Investors and myself.
Today, the Cash Flow is so crazy compared to the prices we paid throughout the 21 years since 1997, that when you look back at these "no cash flow" deals, you begin to realize that the only reason people don't buy them is because they just can't afford NOT to have the cash flow on day one.
Rents quadrupled in my Investments. The Cash Flow is ridiculous.
Over time, you get to understand that Cash Flow is something that only stays the same if you invested in something that is designed to do so like a Coupon Bond.
Because I calculate the FUTURE Cash Flows out 10 years, I fully understand the true return of the Investments and how much cash flow I will achieve.
The other thing to take into consideration is the Mortgage Balance reduction.
If your investment is at break even but your Mortgage is a fixed rate, then one day, when that Mortgage goes away, your Cash Flow increases tremendously.
When you take into account a 30 year projection of your Investment Cash Flows, you realize just how wealthy you can get by buying for FUTURE Cash Flow as opposed to Cash Flow NOW.
It's really not RIGHT to pretend that the Cash flow you receive at the purchase is going to be the same throughout the holding period of the investment. I consider that to be a very naive and kind of a lazy way of doing financial calculations.
So I really would suggest all Investors do at least a 10 year pro-forma projection business plan. The pros do it.... why not everyone here?
Originally posted by @Russell Brazil:
Im going to purchase 2 properties within the next 6 months that will be about break even.
I'm planning to do the same (1 property) within the next few months, which prompted my post. I've looked at the break-even option very carefully and I understand my market. Therefore, I believe its a worthwhile move that will benefit me in the long run without it being speculative.
Originally posted by @Matthew G.:
@Matthew McNeil It can be risky.
Just because your cashflow isn't negative doesn't mean you can't have other issues that will make your investment negative. If your roof starts to leak, AC breaks down, etc., you'll have to deal with expensive repairs while hoping your home's appreciation will come out positive.
If the market corrects and you have to hold on to the property longer, you could be losing money from having to handle repairs while you wait for the home price to go up.
Forced appreciation through rehab is your way to minimize these unexpected costs, not speculative appreciation.
Good points and I agree. I invest in newer homes so I'm not as adverse to as much risk regarding maintenance issues. Granted, the risks are minimized and not removed, but buying newer adds some padding.
Originally posted by @Steve Vaughan:
Some of my best IRRs after all was said and done were break-even during the hold. They broke even with 10% down. Sometimes break even was a choice because I was after equity capture and put them on 15yr mortgages. In 2012 15s had 30% lower interest rates than 30s.
But I purchased mine off-market, below FMV from tired landlords or homeowners with a problem they needed help solving.
Are you paying retail? That would put me in the no camp. We are still investors. Paying retail without cashflow, only hoping for market appreciation is more speculating than investing.
Good points Steve. I've purchased both retail and below-retail and have done very well with both approaches.
I realize my post can be fodder for various rabbit trails of opinions - all of which would valid. My premise was to step back from the word "speculative" and the phrase "hoping for market appreciation" because that's not the intent or motive. Rather, its understanding that home values have historically risen and I'm willing to invest today with a zero cashflow result for the time being with the knowledge (not hope) that both the value of the house and the rental price will increase.
Yes, we are investors as you wrote. But is this something to consider as an investor? I think we tend to trip over the word "speculation" and forfeit an opportunity which is actually not speculative by definition, but rather is based on very careful consideration as seasoned investors.
In today's market, I believe there's opportunity for some investors (not all) to carefully position themselves without it being interpreted as speculation.
Originally posted by @Bjorn Ahlblad:
@Matthew McNeil I am a buy and hold MF investor, so I won't buy properties that do not cash flow on day one. An exception might be an empty apartment building that can be readied within a few months for a reasonable amount-100k or so. If you get cash flow you rarely get appreciation and vice versa. Most often appreciation is a matter of where we are in the market cycle, buying now I would expect no appreciation -certainly not for many years. Your goals, market and expectations may be completely different, and that is just one of the many reasons why this business is so great. All the best!
Thanks Bjorn. Good points. Question though. You wrote, "If you get cash flow you rarely get appreciation and vice versa." Doesn't this premise generally apply to older MFs? I invest in newer SFHs and I've received cash flow and enjoyed appreciation on each investment.
Originally posted by @Llewelyn A.:
I would add to your requirements that the Investor does NOT need the cash flow.
If they need the cash flow, then this will NOT work for them.
This narrows down the kind of Investor that should follow this strategy.
The only added Caveat I would say is that I include your JOB as a cash flow.
So if you are making a lot of money in your profession, then how is an extra $100 per month or even $1k per month going to somehow help you?
In my case, when I started out in 1997 in Brooklyn, NYC, I didn't buy for Cash Flow because that Cash Flow was just wasn't NOT needed. My Salary rose from an Entry level programmer of $32k in 1997 to well over $100k by the year 2000.
What also helped was that I lived below my means.
Combining having a good paying profession and living below my means, it allowed me to pursue Investments with Disposable money. That's actually the wisest way to invest. Invest with money you DON'T need.
This helped me to make over $10 Million in unrealized Appreciation for my Investors and myself.
Today, the Cash Flow is so crazy compared to the prices we paid throughout the 21 years since 1997, that when you look back at these "no cash flow" deals, you begin to realize that the only reason people don't buy them is because they just can't afford NOT to have the cash flow on day one.
Rents quadrupled in my Investments. The Cash Flow is ridiculous.
Over time, you get to understand that Cash Flow is something that only stays the same if you invested in something that is designed to do so like a Coupon Bond.
Because I calculate the FUTURE Cash Flows out 10 years, I fully understand the true return of the Investments and how much cash flow I will achieve.
The other thing to take into consideration is the Mortgage Balance reduction.
If your investment is at break even but your Mortgage is a fixed rate, then one day, when that Mortgage goes away, your Cash Flow increases tremendously.
When you take into account a 30 year projection of your Investment Cash Flows, you realize just how wealthy you can get by buying for FUTURE Cash Flow as opposed to Cash Flow NOW.
It's really not RIGHT to pretend that the Cash flow you receive at the purchase is going to be the same throughout the holding period of the investment. I consider that to be a very naive and kind of a lazy way of doing financial calculations.
So I really would suggest all Investors do at least a 10 year pro-forma projection business plan. The pros do it.... why not everyone here?
Llewelyn, excellent feedback and I should have included your first comment as a 3rd caveat; "I would add to your requirements that the Investor does NOT need the cash flow" - which I meant to say.
People automatically surmise that zero cashflow for the time being translates to speculation.
The title of my post is "are you willing" to consider other options [without it being immediately interpreted as speculation].
Several nuggets in your feedback post. Thanks!
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Originally posted by @Matthew McNeil:
Originally posted by @Steve Vaughan:
Some of my best IRRs after all was said and done were break-even during the hold. They broke even with 10% down. Sometimes break even was a choice because I was after equity capture and put them on 15yr mortgages. In 2012 15s had 30% lower interest rates than 30s.
But I purchased mine off-market, below FMV from tired landlords or homeowners with a problem they needed help solving.
Are you paying retail? That would put me in the no camp. We are still investors. Paying retail without cashflow, only hoping for market appreciation is more speculating than investing.
Good points Steve. I've purchased both retail and below-retail and have done very well with both approaches.
I realize my post can be fodder for various rabbit trails of opinions - all of which would valid. My premise was to step back from the word "speculative" and the phrase "hoping for market appreciation" because that's not the intent or motive. Rather, its understanding that home values have historically risen and I'm willing to invest today with a zero cashflow result for the time being with the knowledge (not hope) that both the value of the house and the rental price will increase.
Yes, we are investors as you wrote. But is this something to consider as an investor? I think we tend to trip over the word "speculation" and forfeit an opportunity which is actually not speculative by definition, but rather is based on very careful consideration as seasoned investors.
In today's market, I believe there's opportunity for some investors (not all) to carefully position themselves without it being interpreted as speculation.
this is highly regional ... for those responding that live in markets with no real historic appreciation or values have actually fallen since the peaks of the 90s.. there is no reason to buy anything that does not cash flow.. who wants the risk and stress of landlording if there is no real appreciation upside.
as to Steve's comments on IRR that to me is the metric.. i have bought almost all my west coast properties that were break even to negative and once i exit.. the IRR far exceeds anything i could have gotten with a non appreciating " cash flow property"..
However i am in the business so its not really apples to apples to compare to most of the investors who are working a job and investing on the side.. I totally get why they want to buy their rental portfolios and if at the end of the day they make a grand or two a year on a house and it becomes paid for by the tenant thats still a good out come
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Originally posted by @Jay Hinrichs:
Originally posted by @Matthew McNeil:
Originally posted by @Steve Vaughan:
Some of my best IRRs after all was said and done were break-even during the hold. They broke even with 10% down. Sometimes break even was a choice because I was after equity capture and put them on 15yr mortgages. In 2012 15s had 30% lower interest rates than 30s.
But I purchased mine off-market, below FMV from tired landlords or homeowners with a problem they needed help solving.
Are you paying retail? That would put me in the no camp. We are still investors. Paying retail without cashflow, only hoping for market appreciation is more speculating than investing.
Good points Steve. I've purchased both retail and below-retail and have done very well with both approaches.
I realize my post can be fodder for various rabbit trails of opinions - all of which would valid. My premise was to step back from the word "speculative" and the phrase "hoping for market appreciation" because that's not the intent or motive. Rather, its understanding that home values have historically risen and I'm willing to invest today with a zero cashflow result for the time being with the knowledge (not hope) that both the value of the house and the rental price will increase.
Yes, we are investors as you wrote. But is this something to consider as an investor? I think we tend to trip over the word "speculation" and forfeit an opportunity which is actually not speculative by definition, but rather is based on very careful consideration as seasoned investors.
In today's market, I believe there's opportunity for some investors (not all) to carefully position themselves without it being interpreted as speculation.
this is highly regional ... for those responding that live in markets with no real historic appreciation or values have actually fallen since the peaks of the 90s.. there is no reason to buy anything that does not cash flow.. who wants the risk and stress of landlording if there is no real appreciation upside.
as to Steve's comments on IRR that to me is the metric.. i have bought almost all my west coast properties that were break even to negative and once i exit.. the IRR far exceeds anything i could have gotten with a non appreciating " cash flow property"..
However i am in the business so its not really apples to apples to compare to most of the investors who are working a job and investing on the side.. I totally get why they want to buy their rental portfolios and if at the end of the day they make a grand or two a year on a house and it becomes paid for by the tenant thats still a good out come
Completely agree. An added point - much of the premise is based on the region where the investor is building his/her portfolio as you've clarified.
Thanks Jay.
I never invest on appreciation potential. It's what it's worth right now today and what the cash flow is .
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Some areas can appreciate whether you like it or not. I think most will take that into account if it logically exist. If it does not or there is no way to force it then that is another game. Keep in mind when areas appreciate so does the rent and eventually higher appreciation areas can have very high CF if not the highest compared and even above 2% level is very common for the longer runs. If we can go back decades one might find appreciations in the 10x levels and CFs %s in double digits. This commonly happens in high appreciation areas and rarely happens other places. So if you are "investing" some might look for areas and assets that can appreciate. How this comes up as even debatable on an investment forum is odd to say the least.
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It is very easy for indivulaes to post that they have made significant gains through appreciation and for that reason cash flow is of a lesser value. Unfortunately the tens of thousands of past investors that have for multiple different reasons been forced to liquidate during down markets and take a significant loss are generally speaking not on this forum.
Appreciation investors are speculating, plain and simple. Speculation is not a dirty word but it is not the same as investing for income.
Personally I believe I will benefit from appreciation when I sell but there was never any intent on my part to rely on it as a expected positive outcome. Faith investing does not rely on fact, it relies on a expectation that what happened yesterday will happen again tomorrow ignoring all evidence to the contrary.
Additionally for those that believe cash flow increases over time due to various different factors, rent increase, reduced debt etc. in the truest since of the definition of cash flow if a "property " does not have positive cash flow from day one it can never have true positive cash flow. It is very easy for investors to ignore the value of growing equity and pretend they have increased cash flow but only the most naïve of investors would actually believe that to be true. Manipulation of numbers is all too easy. Ignoring numbers even easier. For example one could pay cash for a 1M dollar new build property and claim to have positive cash flow with rent of $2500 per month. This is the most commonly used method to increase a investors perceived cash flow.
Investors inflate their cash flow numbers by using yesterdays repair costs (often the case with new properties) which as we all know is purely rear view thinking. Expenses can only be calculated on the day a property is sold. Until then we all make up numbers through various methods of guestimating.
If you invest for cash flow and view appreciation only as a possible added bonus there is zero reason to invest in any property that has break even or less cash flow. It simply is not a logical business decision to do a complete 180 on your investment strategy.
All investing has some degree of speculation. It comes in different risk forms and many have lost on either or both. When we look physically at structures around American cities it seems obvious that more lost speculating on just cash flow. Here is two pictures of two streets compared in a multi decade time span as extreme examples, one of a cash flow only area and one pic of both CF/AP.
Which investors do you think had the better and more reliable returns?
@Matt R. It's not an apples-to-apples comparison. The developer in this case added value and didn't just hope for natural appreciation. Sure he had to make some speculations on whether developing a new building would generate more cash flow, but he could easily calculate comps of nearby rentals, find out the cap rate and figure out whether the construction costs would exceed the value of the developed property.
I wouldn't say hoping for natural appreciation is bad, it just depends on how much risk you are willing to take and how well you know the market. If you buy a property today with zero cash flow, and the market corrects in a year and lasts for a couple years, are you okay with waiting? The areas that have the highest appreciation also have higher fluctuations in price when the market corrects. You may not be losing money, but you have an opportunity cost because you will have to sit on the sidelines while your cash sits in that property.
I think you have to consider opportunity costs when you are betting on natural appreciation. If it doesn't appreciate as much as you expected or market correction happens, could you have made better gains somewhere else?
I fall mostly into the @Llewelyn A. (I am a fan - virtually always agree) camp but I purchase the best investment for me available (takes into account expected return and expected effort). I have never purchased a cash neutral property that did not have an obvious value add. I have only purchased a single RE that I projected as cash neutral property and it had a $45k to $60K value add.
In my primary market, the long-term appreciation track record goes back at least 60 years. I track vacancy, employment rates, net migration, supply/demand, etc. Some may call expecting appreciation in that market speculation but it is high probability, educated speculation which to me makes it investing.
I would also point out that cash flow projections are also projections. Ask anyone that was invested in Detroit at the start of the Great Recession what happened to their cash flow. Detroit was far from alone; there were many cities that had significant drop in cash flow during the GR.
If the best investment available was cash neutral but MY conservative return projection showed it to be the best investment available at that time, I would not hesitate to purchase it.
I understand that some RE investors require positive cash flow and they cannot purchase without cash flow. I do not need cash flow and I more value the total return. Therefore 0 cash flow would not deter my purchase.
@Matthew G. I hear ya, I did not mean to factor in Dev although that is another investment door that could open up down the road in the more high appeciation areas. This is where it can be a huge difference in the end. If we go down that comparison forgettaboutit right. Here is one real world example. Guy buys 14 units in the mid 90s for 400k. 25 years later after milking well above 2%, he redevs into 24 condos worth 20 million.
As far as do high appeciation areas have more risk during slow downs? That depends I guess. Some very high appreciation areas lost virtually nothing as other lessors areas even nearby lost 50%. For example Santa Monica median sfr peak pre reccession was 850K and the low during the reccession was 825K. Now that has doubled. All the rules might be very location specific.
Side note:
New report says Santa Monica has the nation's highest rental prices ...
Jan 5, 2017 - A new rental report lists the city as the most expensive rental market in the United States, with median monthly prices of nearly $5000
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If you don't need the cash flow, and the property breaks even in the current market, then you're really just speculating, and if you have the money to speculate it may not matter one way or the other, much like it may not matter if you go to Vegas and blow a grand at the casino if you have the grand to blow.
Webster defines investing as "expending money with the expectation of achieving a profit". I'm not sure you can reasonably have an expectation of profit on appreciation alone, because no one can predict the future. That said, solid houses in solid neighborhoods will usually go up in value, so it's not quite the same as pulling a slot lever.
Would I do it? Probably not. I expect cash flow AND a reasonable expectation of appreciation. But my wife says I'm really picky :D
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All properties cash flow. Many investors however choose to (or by nessecity) to use leverage to purchase the asset.
- Russell Brazil
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Originally posted by @Matthew McNeil:
Originally posted by @Thomas S.:
No. Speculation on appreciation does not fit my investing for income business needs. In most markets speculation on appreciation is way too risky.
With no guarantee of future pay out having no expectation of income does not make it a worthwhile investment. This approach is best left to those that specialisation in faith investing.
Thomas, I agree to an extent. However, just for the sake of fleshing this out a bit more I’ll offer this. The initial zero-sum cashflow (at the time of purchase) will increase over time (2-3 years) as the rent increases resulting in a future positive cashflow. And, since home values historically increase in value (4-5%) then I’m going to gain on that side as well.
I agree with your comments, but if we view it as "speculative" then it creates a barrier rather than looking as the idea as part of a carefully considered strategy that's willing to include a break-even investment for the time being. Granted, I'm not proposing this for all markets. I bought a SFH in 2015 in my target market for $206K. Today its worth $280K.
I share the challenge many REIs currently face concerning these higher purchase prices that limit our willingness to invest – zero cashflow being a primary issue. But if we’re willing to make the investment – not as a loss – but at an initial zero-sum gain then I feel its worthwhile to consider.
Your thoughts?
Real estate values have not increased 4-5% historically, they have tracked inflation give or take a fraction of a percent.
