Buy-and-hold philosophies: Cash flow vs Appreciation

[Phil Sharp]

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.  

[Llewelyn A.]

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.