Choosing a House Hacking Market?

Question

Hello everyone,

I often hear the terms cash flow market and an appreciation market? When choosing a market how can I analyze to differentiate between the two? What are the biggest factors that contribute to each type of market that make them their own?

Ty Coutts · Answer

Hello, Austin Nicol, understanding the difference between cash flow markets and appreciation markets is crucial for real estate investors, as each type of market aligns with different investment strategies and goals. Here’s a detailed breakdown of these two types of markets and the factors that contribute to each:

Cash Flow Market, a cash flow market is one where rental income exceeds the expenses of owning the property (mortgage, taxes, insurance, maintenance, and property management), resulting in positive monthly cash flow for the investor.

Key Characteristics:

High Rental Yields: Properties typically have high rental yields compared to their purchase prices.
Stable or Slow Appreciation: Property values increase slowly over time, if at all.
Lower Property Prices: Generally, property prices are lower, making it easier to achieve positive cash flow.
Higher Rental Demand: Strong demand for rentals due to economic factors, demographics, or local employment conditions.

Factors Contributing to Cash Flow Markets:

Economic Stability: Stable job markets and steady local economies that support rental demand.
Rental Market: High percentage of renters compared to homeowners.
Affordability: Affordable property prices relative to rental income.
Local Policies: Landlord-friendly laws and regulations.

Appreciation Market, an appreciation market is one where property values increase significantly over time, offering substantial capital gains upon sale, but rental yields may be lower, resulting in lower monthly cash flow.

Key Characteristics:

High Property Value Growth: Significant annual increases in property values.
Lower Rental Yields: Rental income may not cover the monthly expenses, leading to lower or even negative cash flow.
Higher Property Prices: Generally higher property prices, which can make it harder to achieve positive cash flow.
Strong Economic Growth: Rapid economic growth, population influx, and development.

Factors Contributing to Appreciation Markets:

Economic Boom: Strong local economy with job growth and high-paying industries.
Population Growth: Influx of people moving to the area, increasing demand for housing.
Infrastructure Development: Significant investments in infrastructure, amenities, and services.
Desirability: High quality of life, good schools, and attractive neighborhoods.

I hope this information finds you well.

Alecia Loveless · Answer

@Austin Nicol I’m starting to have to decide whether I’m going to buy properties that dont cash flow for the first time. My region is experiencing a glut of sellers who think their property is worth much more than the numbers dictate. However I can still get appreciation.

With a 20% down payment I’m seeing deals now that are -$200/unit/month when previously they have always been +$200/unit/month.

I’m now looking off market more.

Rick Albert · Answer

It comes down to your goals.

Because you are house hacking, often times you aren't cash flow positive for a while because of the low down payment. In which case I like the idea of looking in more expensive markets to house hack and get that appreciation.

I'm up to 10 doors (including personal residence) and have six more under contract. I haven't done a down payment of my own funds since 2015. I used HELOCs, 1031 Exchanges, and partnerships to expand the portfolio. I never would have been able to do it if I didn't start house hacking in Los Angeles.

Drew Sygit · Answer

@Austin Nicol In our opinion, the Class of tenant drives everything.

So, figure out which Class of tenants are attracted to which Neighborhoods in a city.

Typically, you'll also see sales & rent price levels that signify the different Classes.

It may not be easy, but we feel it's worth it to put the work into all this for better investing success!

James Wise · Answer

Choose the market you are most comfortable with. All other factors, not as important as this.

Austin Nicol · Answer

@Ty Coutts  @Drew Sygit Thank you both for your replies, I now know exactly what class of property I am looking to invest in to meet my goals. What are some of the tools and tips you guys use to divide a market and see which sub markets have which kinds of property classes?

Drew Sygit · Answer

@Austin Nicol a good analysis by @Ty Coutts, but he left out info about Property Classes.

Rising real estate prices and mortgage rates have made it all but impossible to cashflow on Class A properties, and challenging on Class B. So, many investors are moving down to Class C without fully understanding the corresponding risks.

Read more in copy & paste below:

Recommend you first figure out the property Class you want to invest in, THEN figure out the corresponding location to invest in.

If you apply Class A assumptions to a Class B or C purchase, your expectations won’t be met and it may be a financial disaster.

So, when investing in areas they don’t really know, investors should research the different property Class submarkets.

Here’s our OPINION for the Metro Detroit market (use as a template for your target area!) that we’ve learned in our 24 years, managing almost 700 doors across the Metro Detroit area, including almost 100 S8 leases.:

Class A Properties:
Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% the more recent norm.
Tenant Pool: Majority will have FICO scores of 680+, zero evictions in last 7 years.

Class B Properties:
Cashflow vs Appreciation: Typically, decent amount of relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% should be applied only if proper research done to support.
Tenant Pool: Majority will have FICO scores of 620-680, some blemishes, but should have no evictions in last 5 years

Class C Properties:
Cashflow vs Appreciation: Typically, high cashflow and at the lower end of relative rent & value appreciation. Can try to reposition to Class B, but neighborhood may impede these efforts.
Vacancy Est: Historically 10%, but 15-20% should be used to also cover tenant nonpayment, eviction costs & damages.
Tenant Pool: majority will have FICO scores of 560-620, many blemishes, but should have no evictions in last 2 years. Verifying last 2 years of rental history very important! Also, focus on 2 years of job/income stability.

Class D Properties:
Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation
Vacancy Est: 20%+ should be used to cover nonpayment, evictions & damages.
Tenant Pool: majority will have FICO scores under 560, little to no good tradelines, lots of collections & chargeoffs, recent evictions. Verifying last 2 years of rental history and income extremely important to find the “best of the worst”.

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.

Choosing a House Hacking Market?

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