Cash Flow vs. Appreciation: the Numbers

This has been a topic on my mind for a while. I recently had a debate with someone in BP regarding investing for cash flow vs. appreciation. You can find examples all over the web supporting both strategies. I favor cash flow investing because I want to change today rather than tomorrow. Cash flow is known and relatively solid. I don’t have time for inflation or gentrification to do its thing and hope there is no downward cycle. I want results that I can understand and reliably predict. The other investor claimed that investing in negative cash flow properties in appreciation areas is the way to  build real wealth. He insisted that I look at the numbers and present my findings to prove him wrong. At that moment I had never sat down and worked the numbers. I also doubt that he ever had because he refused to present his own side. Well, I’ve sat down and worked the numbers.

Because the appreciation investor was in Hawaii, and Hawaii is an appreciation market, I decided to run my appreciation numbers from Oahu. Mahalo! I actually lived in Hawaii for 4 years while serving in the Infantry. I considered buying a property on Oahu last year and could not bring myself to spend my capital in that type of market. The distance, cost of travel, and because it goes against my desire to make cash flow today, not appreciation tomorrow meant it did not fit my strategy. I found long-term appreciation numbers for Oahu from the Honolulu Board of REALTORS here. I calculated the rents and vacancy from the Department of Numbers here. This allows me to use actual data from Hawaii rather than speculate. Basically, they have 4.9% appreciation, 2.5% rent increase, and 8% vacancy. NOTE: I was extra nice regarding vacancy. Hawaii has a very high vacancy rate but I wanted to be super conservative in my numbers.

The definition I will use for a cash flow property is by following the 1% rule. That means that if you buy a property for $100,000 it should rent for $1,000/month. Finding statistical numbers for cash flow markets was a bit harder because no one seems to care about these places. Most of these markets today are in the mid to mid-West US, and Memphis is commonly considered the cash flow investor’s Mecca. Now before you begin arguing, I know you can do MUCH better than 1%. I just bought a property last year for $82,000 that rents for $1,100/month. That’s over 1.3%! Again, for the sake of politeness to my appreciation friend I have used simple and conservative numbers. I even left vacancy at 8%, which I have yet to see. I also left management at the same cost even though fees are more easily negotiated when you have more doors being managed. I ended up settling on a 1.5% appreciation rate and 2% rent appreciation, which seemed to closely represent the markets I’ve looked at.

So let’s look at the numbers! If you aren’t a numbers person, just skip past all this garbage to get to the results! I assume roughly $100,000 to invest. It actually cost just over that for both methods, but that is beside the point. We’ll look at 2 different points in time: 10 years and 20 years. In the appreciation market you can buy 1 SFR for $500k. In the cash flow market, you can buy 5 SFR for $500k. I used current property tax rates for both areas and did not change them through the life of the project, so try to keep in mind that this is not an absolute 100% model.

I hope the images work. I had tables but the site stripped out the formatting. It shows it when I paste, but not when I actually hit to publish. Here are the 10-year results for both investing methods:

So we can see that the cash flow investor is ahead by nearly $50,000 after 10 years. Of course, appreciation is most powerful when it can compound, so let’s see the full numbers out to year 20:

There is a bright spot for the appreciation investor here: only 1 unit! They have far less in terms of numbers of headaches, though I would say that the constant fear of an injury, loss of job, market downturn, expensive eviction, or anything else is a much larger headache.Okay, now we’re talking! "Get some!" sayeth the appreciation investors. Like how I did that? That’s sarcasm in case you missed it. So now we have the appreciation investors ahead of the game by around $30,000 after 20 years. That’s not much of a stretch. Quite anticlimactically, they’re basically the same results until we consider what you did for the past 20 years. As a cash flow investor you are not sitting still. You are expanding! You have positive cash flow that meets basically every bank’s desires for DSCR so you can keep buying more properties as your cash flow allows. At year 5 you could have bought another unit, then year 8-9, then… you see what I’m getting at? Now, the appreciation investor can pull out equity with a LOC or a cash-out refinance, but how many properties can they sustain, each at a loss of income? The only real exit strategy becomes selling the property to reinvest the proceeds into a different type of asset. Into what do they go? Who knows, but unless they have a very high income job they cannot afford to grow their losses. This type of investor had better hope there is no downturn and they lose their job or that the market doesn’t turn at the wrong moment for them. If so, they’re sunk. This investor is playing a game best left in the stock market. Buy low, sell high is the only real hope or exit.

Okay, this was a pretty long post, but I wanted to get some numbers out there. To be honest, I thought cash flow would destroy appreciation. Of course, with better investments it would, but that’s the same thing the appreciation person will say so I won’t fall into that trap. Let’s leave it at this: real estate investing can be done in many different ways to fit many styles of investing. All of the strategies win if implemented correctly and all of them lose if not.

Until next time, best of luck and happy investing!