How To Know If Cashflow Or Appreciation Is More Important
There are hundreds of reasons to love owning rental properties. Many people will tell you there's no better vehicle for wealth creation. I agree.
Today, I want to focus on two of the biggest benefits investors seek when analyzing rentals. Cash flow and appreciation.
There is an often-held debate about which is more important. To start, I’d like to point out that the answer to this debate is nuanced. That makes it difficult to give blanket answers. I don’t propose to give you an answer, but I will try to point out some things you may not have thought about concerning these two benefits. I’ve learned these while building a portfolio of 50+ units and helping dozens of other investors build their portfolios.
Cash Flow from Appreciating Areas
Cash flow is undeniably more reliable when it comes from areas experiencing steady appreciation. Properties in appreciating markets tend to see rental income rise over time as property values and demand increase. This creates a compounding effect where both equity and income grow, enhancing the long-term value of your investment.
Balancing Cash Flow with Personal Income
If your primary business or employment generates high monthly income, cash flow from your rentals may become less critical. In this scenario, you can focus more on properties with high appreciation potential, aligning your portfolio with wealth-building strategies rather than immediate income generation.
Portfolio Objectives: Cash Flow vs. Appreciation
Individual acquisitions don’t have to conform strictly to cash flow or appreciation goals. The best choice depends on your current portfolio objectives. Sometimes, prioritizing cash flow makes sense, while at other times, appreciation might be your focus. It’s not about one being better than the other but optimizing your portfolio for your goals.
Beware of Yield Traps
What looks like great cash flow on paper can often be a yield trap. High cash flow projections often don’t accurately account for the inevitable costs of vacancy and maintenance, which can eat up your profits quickly. Always keeping an eye on quality (demand, year of construction, etc) can help you avoid these traps.
Appreciation vs. Inflation
It’s important to distinguish true appreciation from inflation. What some investors perceive as appreciation may simply be the effect of rising prices due to inflation. To identify genuine appreciation, subtract inflation rates from price increases. While inflation-driven equity growth still adds to your net worth, it’s not necessarily a result of skillful property selection. As they say on Wall Street, "Don't confuse brains with a bull market."
The Role of Net In-Migration
Net in-migration is one of the most significant drivers of appreciation. When more people move into an area, demand increases, which drives up prices. This effect is amplified in markets constrained by natural barriers such as water or mountains, where land availability is limited.
Cash Flow for Living Expenses: A Cautionary Note
Using rental income as your primary source of living expenses is generally not a good idea unless you own the property outright with no mortgage. Even then, this strategy can create poor incentives around property maintenance, as preserving cash flow might take precedence over necessary upkeep. Based on personal experience and observations, relying on rental cash flow to cover living expenses is possible but rarely optimal.
Conclusion
I hope these points gave you something new to consider in the ever-burning debate between cashflow and appreciation. Both are important, and unfortunately, the analysis isn’t black and white.
I’ve always believed in putting your money where your mouth is. Last year I moved my family of 7 from a “cash flow” market to a market I believe has more long-term appreciation potential. That’s where I want to build our business and portfolio.
My thesis is this: stable, growing, cashflow that will allow us to realize appreciation gains over the long term.
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