Is lower cash flow a deal breaker?

Question

How do you all feel about multi that doesn't have incredible cash flow as-is but that's rehabbed, in a stable market and in an area that should have a bit more appreciation than other areas of the city? I've run into investors who don't mind because they plan to put more down and just want a safe place to park cash especially while inflation appears to continue to be on the rise. They seem to emphasize appreciation, the areas of value add on the property, and tax shelters. However, I have others that shudder at the thought of net income of ~$500/month when they put 25% down on 850k. I'm curious what you all see as pros/cons and how much weight you place in each category.

Erik W. · Answer

Hi @Kiera Underwood, You've outlined the basic Pros and Cons already. Some people are willing to accept minimal (and even negative) cash flow in exchange for significant appreciation, or as you said, just to "park" money somewhere for awhile. Think of Walt Disney when he tied up the vacant swamp land in Florida that eventually because Disney World. That's an extreme, well-publicized example, but many investors do that each day when they know something is poised to take off. Then again, it's a gamble. The dustbin of REI history is littered with "can't miss opportunities" that had people feeding the alligator for years...decades even...wait for the town to grow that direction, or for the right developer to come along, etc. It all boils down to risk and reward: appreciation is a high risk strategy in my book, because laws and markets can change, and there are no guarantees of a payoff. But if payoff comes, it can be incredible. One piece of solid advice: make sure you have DEEP pockets if you're an appreciation-only investor. All that said, I'm a cash flow investor. I love my "little ATMs" as I call them. Little 2-bed room Class C houses/plexes and small commercial units (< 1800 sq ft) that rent for under $1,000 / month, but about 65-70% of that is money in the bottom line NOI! You can wait for your cake, or you can eat today. Sometimes if you're very lucky, you can do both. Personally, I like to improve cash flow with commercial property, which also increases the value via forced appreciation. I'm not a fan of buying places that tie up cash and pour loads of money into them for years hoping for the big prize.

Jackson Babcock · Answer

As others have stated, buying for appreciation is a very speculative investment. My personal opinion is to always buy for cash flow, especially when using leverage. Capital preservation is our number one priority. Buying for appreciation is gambling in my eyes, not saying you can’t make money but it can be risky. I like having control over the properties and having the ability to force appreciation by driving up NOI.

Benjamin Aaker · Answer

@Kiera Underwood I think for some it is as simple as that. They have a large amount of cash they held back for whatever reason (like a pandemic and worry of a market crash) and now want a place to put it so they aren't losing value due to inflation. They are high performers and don't need income but they want a place to put that money that has the likelihood of a return (equity build from rents, appreciation).

Benjamin Aaker · Answer

The tradeoff should be more of a cashflow vs equity build. Most agree that buying for appreciation is a gamble and you should avoid it. But, you can set up your mortgage so that you pay down debt faster. The price is cashflow. Certain high-performing investors would rather have this than extra taxable income (even after considering depreciation). They want to build equity with the plan to cash out or live off cashflow when their current income goes away.

Jeffrey Donis · Answer

I agree with @Erik W.. Cash flow is not the end all be all. But, it is a major factor when determining if you should invest in a particular property. I know some investors will not buy a property that doesn't cash flow. I guess there would need to be a good reason to buy a property that justifies acquiring it despite its low cash flow. But, this is definitely something to pay attention to, because cash flow is the main source of "passive income" in real estate, which is why many investors get into this industry in the first place.

Taylor L. · Answer

Putting more down isn't really increasing the cash flow of the property, it's just reducing the cost of debt. Why buy a negative cash flowing property betting on future appreciation, when there are positive cash flowing properties out there?

Bonnie Low · Answer

Like all things in real estate: it depends. Some people invest for appreciation. Others prefer cash flow. We're looking to retire early and to do that, we have to replace our W2 income so we're cash flow investors. It can also depend on how much cash you have to work with. Typically, markets that have strong appreciation have a higher entry point so if you're just getting started or have little to work with, you might look for a lower cost of entry, which typically generates cash flow but can't be depended on for appreciation.

James Ma · Answer

Kiera Underwood · Answer

@Eric James I don't like to be too speculative, but it's in an area that's obviously developing more than other parts of city. It's just outside of the two biggest employers in the city but on the side of those employers that hasn't been developed as much. @Benjamin Aaker thank you for the input! I wanted to make sure there wasn't something I was missing. @Todd Dexheimer This property does have opportunities to increase cash flow. PM has said that rent rates can be increased by $15-$25/unit at tenant turnover. There's also a vacant lot that could be developed for more cash flow or just sold. I'm also really curious about what charging water back to the tenants would look like or getting a more competitive trash service. Overall I know it will sell, but just getting the ducks in a row!

Eric James · Answer

"... it's in an area that should have a bit more appreciation" doesn't sound very convincing.