Buy-and-hold philosophies: Cash flow vs Appreciation

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Buy-and-hold philosophies: Cash flow vs Appreciation

Phil Sharp
Member since 2018 · 20 posts · 26 votes

On some other threads, there seems to be an underlying debate or difference in philosophy around buy-and-hold investment strategy:  

In one camp, the goal is to invest in high appreciation areas, even though they are high-priced and might not be cash flow positive in the near term.  The idea is that the appreciation will far outstrip the relatively modest cash flows you'd be able to get in lower priced areas.  These folks might argue that, in highly desirable areas like coastal California, you can pretty much bank on solid appreciation over time.

In another camp, cash flow is seen as king, and appreciation the icing on the cake.  The idea for these folks is that if you are banking on appreciation, you are essentially speculating rather than investing.  These folks try hard to find areas that are likely to see at least modest appreciation over time, but the key difference is that they don't bank on it.

Maybe the ideal is somewhere in between, as I know it is not a binary, either/or decision. I would love to hear how different buy-and-hold investors have charted a path between these two extremes.  I have some roots and a property in coastal California and have seen the benefits of this appreciation first-hand, but the costs still blow my mind and I don't have a ton of cash to throw around.  

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Llewelyn A.
Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
7y

The reality is that if you analyze an Investment for it's Long Term ROI, you won't be using simple formulas based on Cash Flow Now.

Those that are arguing Cash Flow versus Appreciation need to add at LEAST the Mortgage Balance Reduction and the Tax Savings.

The problem is Education, therefore, there will always be a discussion which pits Cash Flow versus Appreciation when the real conversation should be:

Given the over all 10 year holding period, what would be the overall return, taken into account:

1) Cash Flow

2) Appreciation

3) Mortgage Balance Reduction and

4) Tax Savings

5) Repairs and Renovations

6) Expense and Revenue increases

etc.

A typical Chart in my spreadsheet looks like this:

The BIG GREEN Number is an Internal Rate of Return and it shows that, according to my CONSERVATIVE Assumptions that has been built into this spreadsheet, it will give me a 15.34% IRR over 10 years.

What I see from other postings is no mention of the overall Return. Therefore, it's somewhat muted to give an answer to the effect Cash Flow is Better than Appreciation.

The Reality is that you should be saying that this Strategy has a better IRR than that Strategy given these Investments.

The Issue I see is not whether Cash Flow is Better than Appreciation, it's what is your understanding of the Financial Calculations and Returns of an Investment.

If we all understood these financial calculations, believe me, we wouldn't have these discussions. It would just be, oh, yes, I understand why you paid $X for that property!

BUT, when people don't understand what 15.34% IRR means, NOR do they understand how the Chart was created and what it means, nor do they do any assumptions or projections...... you might as well throw darts at a board of Investments for sale. Hopefully that dart picks the right one!

In my case, I'm on my 9th Multi-Family Purchase in Brooklyn, NYC. ALL my properties have been INCREDIBLE Returns.

BTW, don't believe anyone who tells you if you haven't sold you don't get the rewards.

All the Rents for all the properties have been increasing tremendously over years. I reap the cash flows on those. I borrow against the Equity on my properties and then reinvest them.

Furthermore, when you do it this way, you don't pay the large tax obligation that is due on other strategies.

If you only believe in cash flow and basically IGNORE all other profits, you will miss the opportunity, which I fully see many of my colleagues do.

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  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    99% of appreciation investors do so because that is the economics of their local area and they primarily invest in SFHs, no other reasons. Investors in high appreciation areas like CA have few options investing locally. It is natural for them to create justification for their decision to invest for appreciation. They will promote it because it is what is available to them. Highly unlikely you will find many OOS investors choosing to invest in CA. CA investors are faith investors for obvious reasons. If you already have plenty of money you can park it in real estate till you decide to cash out and reap the benefits (maybe).  The principal works until it doesn't work.

    Those that invest for income do so for two reasons. First they do not have deep enough pockets to supplement their tenants rent (or don't want to) and second they are living off of the income. They usually benefit from both a income and appreciation in the long term. 

    The reasons for either option are obvious. Appreciation because there is no other option. Income and appreciation because you do not have the cash to throw at a abnormally high appreciation market and you want/need the security of a steady income.

    I invest in B class multi unit properties with positive cash flow and where value/appreciation is driven by the rental income not by home buyers. That is the inbetween market. I do not gamble on the SFH markets.

    15Reply
  • Frank Chin
    Investor · Bayside, NY · Member since 2017 · 1k+ posts · 1k+ votes
    7y

    Good question. I went through this back in the early 1980's when I started investing in real estate. It depends on a lot of factors. We lived in NYC, a high appreciation area.

    1. Employment: Both my wife and I are highly paid professionals. I was involved in accounting, programming at the time, and my wife in finance. Recently Amazon is locating it HQ2 not far away from us with jobs at salaries of $150K/yr. Our dilemma is should we go to an area where job opportunities are less just to pursue RE.

    2. Family finances: My father in law passed away soon after we married, my mom in law retired, and with life insurance, an insurance settlement, and super saving throughout their lives, she was sitting on a pile of cash, and anxious to get into real estate. After much discussions, it was decided that we join forces. She had a ton of cash, no W2,s we with excellent W2's, didn't have the cash to go into it in a big way. Combined, we were able to buy two triplexes within 2 years, investing 150K in them, something we couldn't do all by ourselves. We put down 35% on the 1st, and over 40% on the second, but got them at 25% below market after looking at close to 80 properties for each. Some people with cash to throw around don't look so diligently and run into cash flow issues.

    3: Life style: We decided to downscale our lifestyle and even do away with our cars for a short while. The first triplex we got we lived in one unit. We decided to buy in an area served by subways and express buses. The 2nd triplex was 20 minutes away, and we can get there by bus. When we have to bring tools over for something major, we took taxis a few times.

    4. Analyze: Did we consider cash flow areas? Yes! We took a year running to Philadelphia, where we wife attended the University of Pennsylvania, had lot of friends there, and familiar with the landscape. In fact, we stayed over a friend's home during our numerous research trips there. Duplexes costing $200K in NYC could be purchased for $40K in Philly at the time. My wife's friend at 28 years of age at the time bought a duplex with $25K from an inheritance, a $15K loan, not a mortgage because she couldn't get one, and then paid off the loan in 3 years, and bought another property soon after. She lived rent free from day one, so cash flow wise it was great.

    5. Comparison: The first triplex we got a $150K, (ARV $200K at the time) in 1983, soared to $350K in 1986, when our next door neighbors going thru a divorce sold in at that price. Cash flow wise, with $50K down, we lived almost rent free. In Phiily, we could've bought 4 or 5 duplexes, have greater cash flow. But do I want to drive to Philly several times a month? So figure this, I made $200K in appreciation just sleeping in my apartment, but have to drive myself nuts to Philly, or have to deal with a PM. My 2nd triplex I got in 1984 for $180K also went up to $350K in 1986. We cash flowed well on the 2nd one because we put almost $100K in for a $180K property which I realize not many people can do.

    Yes, the early 1980s was heady times for real estate. The market crashed in 1987, and it bottomed out in 1993. Fortunately, with the accident of perfect timing, we took a pause in 1985, ran out of cash, and didn't get back in the market till 1994. By then I was attending auctions, bought a nearly new duplex at one for around $200K, (ARV of $325K at the time). moved into it, using $20K from my HELOC, and it's currently $1.375 million. It's now mortgage free. With Amazon locating a few miles away, what effect it will have, it's hard to say. But politicians around here are now complaining it will cause real estate prices to soar and rents unaffordable for the middle class. Sad as it sounds, but then, it's not my problem is it?

    And following discussions of the Amazon move, they are also not looking into "real estate cash flow areas" either, because people making $150K/year don't live there.

    Just to add, my mom in law bought a triplex for $110K in 1981, all cash, and by 2006 was too old to handle it, sold it for $850K. She had a few hundred thousand to start in 1980, went into real estate with us and her other two kids, bought 6 to 7 properties in all. And she made it all back just selling the one after living there 25 years. All the properties were bought in NYC and San Francisco.

    13Reply
  • Shiloh LundahlPro Member
    Rental Property Investor · Gilbert, AZ · Member since 2016 · 3k+ posts · 4k+ votes
    7y

    @Phil Sharp I live in both California and Arizona. I like to invest in Arizona more than California because it is more affordable. Also, Arizona is looked at as a mixed market in that it is both a cash flow and an appreciation market. In my opinion, the appreciation is really where a lot of the money gets made. I sell properties on lease options which is sort of like a long term flip. It helps me be able to capitalize on some appreciation, reduce closing costs big time, and I can capitalize on debt pay down without having to save a lot for cap ex.

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  • Bryan O.
    Specialist · Lakewood, CO · Member since 2014 · 1k+ posts · 1k+ votes
    7y

    @Phil Sharp it depends on what you want out of real estate. If you need a good place to store tons of money that you know you won't need to liquidate with less than 5 years notice, then appreciation investing might be for you. If you want to change your today (i.e. quit your day job) then you cannot appreciation invest because they do not cash flow and banks will only let you have so many failures before your DTI is too high to borrow. I wrote a blog that breaks down the cash flow vs appreciation investing. I used a high appreciation market (Hawaii) compared to a typical 1% market. Guess what? They're basically the same. The difference is that the appreciation play needs to be sold at the right part of the cycle to really make profits, but is way less headache. The cash flow investing can be sold anytime and allows you to continue to grow, snowballing cash flow into more and more deals, but is more headache because there are more units.

    Ultimately, do what is in line with your goals and you won't be far off.

    4Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    Long term hold appreciation investors primarily only have bragging rights. Unfortunately many will die before they reap any real benefit from their investment. They simply do  not know when to sell because  they become obsessed with missing out on appreciation.  Equity in a property has very little actual value and generates the lowest return, dollar for dollar, compared to leveraged investments.  It can also be a negative value due to having to pay higher property taxes.

    There are plenty of equity millionaires out there that could sell and sit back for the rest of their lives earning a descent return with income funds but continue to work and invest because their high priced real estate does not generate enough income on it's own to allow them to retire.

    The problem with appreciation investors is they don't know when to fold. Their is no such thing as enough.

    10Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    7y

    The reality is that if you analyze an Investment for it's Long Term ROI, you won't be using simple formulas based on Cash Flow Now.

    Those that are arguing Cash Flow versus Appreciation need to add at LEAST the Mortgage Balance Reduction and the Tax Savings.

    The problem is Education, therefore, there will always be a discussion which pits Cash Flow versus Appreciation when the real conversation should be:

    Given the over all 10 year holding period, what would be the overall return, taken into account:

    1) Cash Flow

    2) Appreciation

    3) Mortgage Balance Reduction and

    4) Tax Savings

    5) Repairs and Renovations

    6) Expense and Revenue increases

    etc.

    A typical Chart in my spreadsheet looks like this:

    The BIG GREEN Number is an Internal Rate of Return and it shows that, according to my CONSERVATIVE Assumptions that has been built into this spreadsheet, it will give me a 15.34% IRR over 10 years.

    What I see from other postings is no mention of the overall Return. Therefore, it's somewhat muted to give an answer to the effect Cash Flow is Better than Appreciation.

    The Reality is that you should be saying that this Strategy has a better IRR than that Strategy given these Investments.

    The Issue I see is not whether Cash Flow is Better than Appreciation, it's what is your understanding of the Financial Calculations and Returns of an Investment.

    If we all understood these financial calculations, believe me, we wouldn't have these discussions. It would just be, oh, yes, I understand why you paid $X for that property!

    BUT, when people don't understand what 15.34% IRR means, NOR do they understand how the Chart was created and what it means, nor do they do any assumptions or projections...... you might as well throw darts at a board of Investments for sale. Hopefully that dart picks the right one!

    In my case, I'm on my 9th Multi-Family Purchase in Brooklyn, NYC. ALL my properties have been INCREDIBLE Returns.

    BTW, don't believe anyone who tells you if you haven't sold you don't get the rewards.

    All the Rents for all the properties have been increasing tremendously over years. I reap the cash flows on those. I borrow against the Equity on my properties and then reinvest them.

    Furthermore, when you do it this way, you don't pay the large tax obligation that is due on other strategies.

    If you only believe in cash flow and basically IGNORE all other profits, you will miss the opportunity, which I fully see many of my colleagues do.

    25Reply
  • Phil Sharp
    OP
    Member since 2018 · 20 posts · 26 votes
    7y

    @Llewelyn A. Thanks for your detailed answer.  I agree the cash flow vs appreciation framing is too simplistic, and was hoping to solicit more nuanced answers like yours.  So, with your nine properties, were they cash flow positive in the first year?  Assuming not, do you have a philosophy about when you want/need them to be cash flow positive?  I understand your broader point that it isn't all about cash flow, but there's also a practical reality of needing to pay the bills each month, so I'm curious how you manage properties that aren't cash flowing, and for how long.

    @Thomas S. I am not sure I understand your point.  Are you saying that appreciation investors can get trapped in a way, because they can have a hard time turning their equity into leverage (via refinance) due to the negative cash flow that would result?  So the only option they have to generate income is to actually sell the property (which undercuts their appreciation goals)?

    @Bryan O. I would love to dig into your analysis a bit more.  Can you link me to that blog post you mentioned?

    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    7y

    Views on it can vary. If someone makes say 75 a year income from a job or business then after taxes and living expenses there is very little to save to invest. Those investors are trying to get the cash flow to outpace their job eventually and will typically deal with more headache for expected yield.

    Those in other camps do not have much TIME and already make a lot of money. So for them cash flow is important but not as much. It becomes more about tax write offs and protection of down payment with equity growth over the long haul. My clients typically makes 300k to 1 million a year or more at their job or business before counting their real estate investment incomes.

    My goal is to buy in the best areas possible for value add properties on the commercial side where I can force appreciation. Cash flow is icing on the cake but does not compare to equity growth. So a lot of the debate here is what amounts of money you are investing with dictates to an extent the type of assets you can own and the areas you can own them in.

    Now you might could pull funds together with others and then buy something larger and a higher quality property and area that you might not be able to afford on your own etc. I believe in qualities of the areas in each state over going into transitional or questionable areas for expected higher yields and headaches. 

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  • Bryan O.
    Specialist · Lakewood, CO · Member since 2014 · 1k+ posts · 1k+ votes
    7y

    @Phil Sharp I can't link to it, but you can get there on my site. I may have posted it in my BP blog as well, but I recall it had a bunch of difficulties with the tables.

    0Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Thomas S.:

    99% of appreciation investors do so because that is the economics of their local area and they primarily invest in SFHs, no other reasons. Investors in high appreciation areas like CA have few options investing locally. It is natural for them to create justification for their decision to invest for appreciation. They will promote it because it is what is available to them. Highly unlikely you will find many OOS investors choosing to invest in CA. CA investors are faith investors for obvious reasons. If you already have plenty of money you can park it in real estate till you decide to cash out and reap the benefits (maybe).  The principal works until it doesn't work.

    Those that invest for income do so for two reasons. First they do not have deep enough pockets to supplement their tenants rent (or don't want to) and second they are living off of the income. They usually benefit from both a income and appreciation in the long term. 

    The reasons for either option are obvious. Appreciation because there is no other option. Income and appreciation because you do not have the cash to throw at a abnormally high appreciation market and you want/need the security of a steady income.

    I invest in B class multi unit properties with positive cash flow and where value/appreciation is driven by the rental income not by home buyers. That is the inbetween market. I do not gamble on the SFH markets.

    what would you call Vancouver BC investors or Edmonton investors.. faith investors as well.. ??? 

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  • Patrick LiskaPro Member
    Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
    7y

    I will throw in one more way of thinking, invest in an area that does not appreciate much and does not usually depreciate much, has little cash flow but helps with tax deductions and equity increase, by making enough that all expenses are paid by the tenants. this type of investing is for Estate investing, it is for the family, not for current use of cash flow. by the time you pass your kids will be in a good financial position when they inherit and sell the properties, and not have to pay taxes on the inherited income, due to the increase in basis. 

    That's the properties i currently hold, a few more properties and i will be bringing in what i make right now working, in cash flow, and i could live off of that, the rest will be all theirs. i have done a some flips, i have made as little as $100, i have also made $50,000, so there are ways to get money when needed but no matter which type of investing you are doing it is always a gamble, but i think a variety of ways is your best bet, you are taking risks yet having some safe investments for those down times, the next best area may be the worst financial investment if you do not time things right, either buying or selling.

    There are probably investors out there that lose money on their properties but it is a tax advantage/ strategy for them and down the road when they sell, or their kids inherit, it would be worth a lot of money to either one. if you make a lot of money and you need a place to " dump " it, a losing property is a good hiding place especially if the kids inherit it later at current market value.

    There is no wrong way to invest, as long as you have a plan and an exit strategy.

    3Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    7y

    @Phil Sharp

    What I like to tell people when they ask me if a Property is a Cash Flowing Property, I want them to FULLY understand what they are saying, and then ask me the question again.

    To fully understand, here is an Example:

    Investor 1 is thinking of buying 100 Main Street all cash and it will cash flow $1,200 per year or $100 per month.

    IS THIS A CASH FLOWING PROPERTY?

    Now, Investor 2 is thinking of buying the SAME EXACT Property, 100 Main Street, with a Mortgage at 100% LTV, fully financed.... and the Monthly P&I will be $200 per month. This property will have a NEGATIVE Cash Flow of -$200 per month.

    IS THIS A CASH FLOWING PROPERTY OR NOT?!

    It's the same property..... but the difference is how Investor 1 and 2 bought it!

    You cannot really answer the question if an Investment is Cash flowing or NOT because it's not up to the INVESTMENT to cash flow.... it is the INVESTOR that cash flows the Property OR NOT.

    I see it time and time again, in every single book, guru or not.... the CHARACTERISTIC of Cash Flowing is NOT about the INVESTMENT... it's about the INVESTOR.

    This is why we need to focus on other things like Cap Rate and especially IRR.

    Here is another example with a Spreadsheet:

    You are thinking of buying 1 of 2 properties. They both require the same investment, $10k.

    Conservatively, you anticipate in 10 years that the property will not receive ANY appreciation. Therefore, you anticipate it will be sold and you will get back your $10k.

    You can do several analysis with this NO APPRECIATION assumption.

    The normal way people do their Cash Flow Analysis is that they make the assumption that the Cash Flow NEVER changes.... by the way, this is a TERRIBLE assumption because it ALWAYS changes.

    The reason why they make that assumption is because they just don't know how to calculate with ease how to take into account fluctuating Cash Flows.

    In this snapshot, I have 2 Scenarios. Both are based on investing $10k and selling to get back your $10k. Then, Scenario 1 you get your consistent cash flow.... WHICH IS A WRONG assumption, but I did it to show that you can perform the same analysis with an IRR.

    The 2nd Assumption has a start of a negative cash flow but will wind up increasing over time. That's a very typical scenario in NYC, for instance. NOTE, there is no ASSUMPTION of Appreciation because the column after the years uses $10k to investment and $10k as the sales proceeds.

    Here is what the two scenarios look like side by side:

    So it is as easy to do this kind of Analysis.

    The typical Investor on here will just take $1k on the very first year and divide it by the Investment of $10k = 10%. They understand that.

    But what they are failing to understand is that what you have done is assume that the future cash flows will ALWAYS be the same. So that means that the IRR over the 10 years will be 10% as the 1st Scenario demonstrates.

    In the 2nd Scenario, I start of negative $50 per month. BUT.... as I know there is a very large development of a Train Station HUB just a few blocks away, I am using my intellect and know that it will eventually increase my rents as the demand for the area increases.

    Eventually, 10 years from now, and that Train station hub is opened, I will reap the reward of approximately $4k per year or $383 per month increase in cash flow.

    You cannot do this kind of analysis with a Cash on Cash Return.

    You need the Internal Rate of Return.

    When you want to talk to the big boys, the Investment Bankers, the Commercial Lenders, your own Partners, sophisticated investors, etc., you need to understand IRR, how it works and why the one shot CoCR is just not correct.

    When you really understand these calculations.... the all kinds of scenarios can be modeled.

    When you understand all kinds of scenarios, you can begin to predict the future with accuracy as you use your God Given Intellect. After all, we are thinking beings.... so let's put on our IRR thinking hats!

    6Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    Highly appreciating properties typically have high rent growth as well. With patience you will typically cash flow more with the appreciation play than with the cash flow play. The key is patience.

    In 2009 I bought a single family home for $270k. It had free cash flow of about $150 a month. Almost 10 years later, and a refinance later...Today it is worth about $425k, but even better it has free cash flow of about $1600 per month. My entire down payment has easily been returned to me in cash flow, and I have plenty of equity in it. 

    If I told someone they could buy a $270k property in an A class area, in a strongly appreciating market that rented for $2,900 a month....everyone would jump on that of course. But if I told them they had to be patient and wait 10 years for then rent to go up $1,000 a month, much fewer would have that patience.

    This isnt even a particularly good deal for my market either. Its just one Ive held onto the longest. Ive had better ones which Ive sold off.

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  • Mary M.
    Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
    7y

    Can someone please give an explanation of IRR that i can grok? I understand most other metrics, but for some reason the idea of present value of future monies being zero and all just makes my head spin.

    What does the 15,xx % in the above example actually mean?

    1Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    7y

    Both high and low GRM strategies can work well. Lots of "my way or the highway" members on BP...they are just explaining their limitations, not ours.

    6Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    @Jay Hinrichs

    "what would you call Vancouver BC investors or Edmonton investors.. faith investors as well.. ???"

    If they are buying properties that can not possibly produce positive cash flow without having to buy it and all they talk about is how much their properties have appreciated then yes.

    If their primary reason for investing is appreciation and they believe because their property increased in value yesterday it will increase in value indefinitely they are faith investors.

    To believe in infinite appreciation or a almighty supreme being you must have faith because there is no proof.

    0Reply
  • Frank Wong
    Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
    7y

    @Thomas S.

    I agree with Thomas.  At some point, you need your equity to work for you and pay you every month.  I know so many people that are equity rich and cash poor. They have 1-2m in equity in their homes but they live paycheck to paycheck.  No these people are not living extravagant lives.  They bought a house 30yrs ago and its fully paid off and now all their money is trapped in the house.  A millionaire but not enjoying life like one.

    I think in the beginning when you have low funds you need a big equity play.  Something to push you over the hump and get you some real money to play with.  Now that you have the funds you can move into a cash flow play.  If you buy in the right area the cash flow play will create equity.  It's a simple math equation increase rents and value will follow.  Of course, the area also has to be a growing population and major city.  I wouldn't buy a cash flow play in Wyoming (I don't know anything about Wyoming just off the top of my head =)). 

    Everyone has their own strategy and what they think is best.  The key is to find the right strategy to fit your lifestyle.   I was lucky to talk to a real estate investor at an Xmas party 17yrs ago.  He gave me a simple advice. "Cash Flow is King, it's all that matters"  This person is worth over $500m. That stuck with me to this day.

    7Reply
  • Robert C.
    Investor · San Francisco, CA · Member since 2016 · 338 posts · 444 votes
    7y

    @Phil Sharp, Actually, if you look at everyone's answers here closely, I think you'll notice that they all have ultimately adopted a combination of cashflow AND appreciation. The debate, if anything I think, is about what to start with, and that really just depends on your personal financial situation. If you have more available cash and other income, you might start with more emphasis on appreciation/capital preservation vs. the opposite. 

    I'm in one of those "appreciation buying" regions, but to be honest, I don't know a single successful investor here that isn't also putting a lot of rent money in their pocket every month. And the fact of the matter is that most people who started investing in places like the Bay Area from 2009 onwards look like geniuses because they benefitted from huge growth in rent AND equity over a ten year period. You didn't have to spend a dime on capital improvements either, if you didn't want to.

    One other thing is if you have enough income from rentals or some other endeavor, why not put more emphasis on appreciation. There's nothing wrong with passing the tax benefits onto the next generation if you've already taken care of your own lifestyle. 

    3Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    7y

    @Mary M.

    Hi Mary, I know it's going to take a bit of work to really grasp the IRR concept.

    There is a really great book out there: What Every Real Estate Investor Needs to Know About Cash Flow

    You can buy it for under $5!

    You will never find this kind of book on the best seller's list because the majority of people have not been in school for years if not decades, therefore, the math is going to be challenging even though it doesn't go beyond 7th Grade Math.

    I also gave examples of how to work out the IRR in this Posting: Understanding IRR Calculations in Frank Gallinelli's book

    If you can get past the first 3 chapters, you will get a great understanding of the IRR.

    There continues to be others that are posting in this very thread that really need to read that book and try to work out the example that was given in the Posting Thread I linked.

    When someone starts talking to me about Investing, I usually ask them a question to see if I should walk away from the conversation.

    It normally goes like this:

    Hey, a friend of mine put in $1k into an Investment 10 years ago. He recently cashed out on it and collected $11k! WOW! What do you think is the ROI per year on that Investment?

    Most people would say well......

    Profits = $11k minus $1k = $10k.

    ROI = profits divided by the Investment = $10k / $1k = 1,000%!

    ROI / Year = $1,000% / 10 years = 100%!!!!! AMAZING!

    Except.............

    100% per year when you invested $1k initially doesn't amount to $11k in 10 years.

    It amounts to $1,024,000!

    People don't understand this problem unless you understand Compounded Rates of Return.

    The real answer is 27.1% per YEAR!

    With a simple Cash on Cash Return, you would get a incorrect answer.

    With the IRR, you would get the correct answer. Here is the Spreadsheet snapshot:

    Notice that the first table shows what happens if you use 100% for $1k over 10 years. You basically double your money every year and in the 10th Year, you would receive $1,024,000

    Obviously, if you calculated that $1k turning into $11k is a 100% per year return, THAT IS THE WRONG ANSWER.

    You need the IRR to calculate it for you correctly at 27.1%

    This is why EVERY REAL ESTATE INVESTOR NEEDS TO KNOW ABOUT CASH FLOW... and I will throw in the IRR at this point.

    Hopefully the readers of this post will understand that by understanding more sophisticated calculations, you can answer these seemingly easy problems.

    When I get someone, which is very often, that tells me WOW.. that's a 100% per year return!!!!

    I just don't walk away from the conversation.... I RUN AWAY. There is nothing more I need to talk to that person about when it comes to Investing.

    The above example is something that I use to demonstrate why compounded and future calculations are very important for ALL of us Investors.

    If we all understood the calculations, then I wouldn't continue to hear problematic postings indicating how cash flow is better than this or that when the only calculation one does is a Cash Flow NOW (meaning the calculation of a cash flow based on today's rents and expenses).

    Hopefully I have answered your questions and not just beating a dead turkey... I mean horse! haha! 

    6Reply
  • Mary M.
    Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
    7y

    @Llewelyn A.  THANK YOU!  I ordered the book and read the thread you linked too.  I also do a lot of reading on economics so I understand a little bit of how to view RE using that framework.  

    My brain is cranking away processing the info,  and now i am beginning to understand “present value of future cashflow”  

    Is there a number that is considered “good” for that metric or is it really dependant on lots of things?

    1Reply
  • Nick Rutkowski
    Rental Property Investor · Ithaca, NY · Member since 2015 · 1k+ posts · 1k+ votes
    7y
    @Phil Sharp What is your exit strategy? That could be a good determination of what kind of house class you want to buy in.
    0Reply
  • Aaron Hunt
    All Over, USA · Member since 2017 · 689 posts · 756 votes
    7y
    This all comes down to the never spoken part of BP. Mortality. How old are you? How many quality years do you have left? 20-30 = Appreciation + time, unless you can really put that work in for deals and cash flow. 30-50 = Mix, depending on how long your parents lived. 50+ = Cash flow only. 70+ = Get off BP. Modest (since I hurt enough feelings with the above) income earners (<$50k): Focus on your earned income. It’s not cutting it. Average income earners ($75k-150k): House-hack, save up down payments, rehab, etc. High income earners ($150k+): Just park low down payments everywhere you can while young, in break even or cash flow deals, while interest rates are historically low. Let someone else pay it off. You’ll have cash flow and appreciation someday. If you get tired of dealing with owning so many, just put a PM in place and start paying down the properties faster.
    6Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Mary M.:

    @Llewelyn A.  THANK YOU!  I ordered the book and read the thread you linked too.  I also do a lot of reading on economics so I understand a little bit of how to view RE using that framework.  

    My brain is cranking away processing the info,  and now i am beginning to understand “present value of future cashflow”  

    Is there a number that is considered “good” for that metric or is it really dependant on lots of things?

     PV of cash flow is the bed rock of note investing.. 

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    0Reply
  • Account Closed
    Rental Property Investor · Oakland, CA · Member since 2014 · 730 posts · 1k+ votes
    7y
    @Phil Sharp why can’t we have both? Several parts of the Bay Area offer both excellent cash flow and great appreciation. I believe you are in Sunnyvale, which doesn’t have many multi family. You won’t find these possibilities with SFH housing.
    1Reply
  • Scott TarantinoPro Member
    Baltimore, MD · Member since 2017 · 7 posts · 14 votes
    7y

    My real estate investing coach taught me this from day one.....if you are looking to get into real estate as a way to gain financial freedom and work less, then there is only one answer to this question.....CASH FLOW is KING!!   Thanks Mark Owens.  

    Full disclosure--I started doing this one year ago.  I am new in this game and still learning.  I currently only own 3 properties, but they are all cash-flowing $350-500/month.  As long as they are doing so, I never need to worry about being forced into selling--they pay for themselves.  This allows the option of holding the properties until selling makes the most sense for me.  I also gain the mortgage pay-down in equity and the tax advantages of real estate to offset my gains.  Its a win, win, win.

    Cash flow pays your bills, appreciation does not.  Cash flow creates financial freedom, appreciation does not.  Cash flow provides a cushion if things go wrong, appreciation does not.  Cash flow gets you your money now, not in the future (remember the time value of money).

    If you have tons of cash that you are looking to simply park someplace other than the stock market and don't care about cash flow, then buy in highly appreciating areas...but make sure you have enough reserves to pay the mortgage and other carrying costs when the economy or the market tanks and you can't find any tenants.  You need to also be ready to pay for that big maintenance issue (new roof, HVAC system, etc) since you'll have no income from the property.

    I have done a lot of research into this topic as I was getting my feet wet in real estate, and there is no doubt in my mind that CASH FLOW IS KING!!!

    5Reply
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