You can see from my last post that this is certainly a topic on my mind. I recently had a debate with someone regarding investing for cash flow vs. appreciation. You can find examples all over the web supporting both strategies. The great thing about real estate is that every single property is different. Using national or even regional numbers are not going to represent what you will make. Even houses next to each other will perform differently. Now, where was I? Oh yes, my debate. 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. I want results that I can understand and reliably predict. This other investor claimed that investing in negative cash flow properties in appreciation areas is the way to go. He insisted that I look at the numbers and present my findings. At that moment, I had never sat down and worked the numbers. I doubt seriously that he had either, because he refused to present anything other than verbal (typed) diarrhea. Well, I sat down and worked the numbers!
The appreciation investor was in Hawaii, and Hawaii is considered a good 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 there 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, all convinced me to stay true to my path. 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 conservative in my numbers.
The definition I will use for a cash flow property is by following the 1% rule. I will post more about these “rules” another time. For today we will say 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 and so they are less advertised. Most of these markets today are in the mid-West US, and Memphis is commonly considered the cash flow investor’s Mecca. Now before you begin arguing, I know you can do better than 1%. I 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-minded friends I have gone extremely conservative. I even left vacancy at 8%. 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 most closely represent the cash-flow markets I’ve looked at.
So let’s get to 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 I’m trying to keep it simple. We’ll look at 2 points in time after the investment: 10 years and 20 years. Using leverage, you can buy 1 SFR for $500k in Hawaii. In the cash flow market, you can leverage 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 model is not absolute, but the omissions are on both sides, so comparatively it is accurate.
Here are the 10-year results for both investing methods:
| Appreciation Investing | Cash Flow Investing | ||||
| Year | Cash Flow | Equity | Year | Cash Flow | Equity |
| 1 | ($14,429) | $130,953 | 1 | $1,753 | $22,791 |
| 2 | ($13,960) | $163,403 | 2 | $1,976 | $25,663 |
| 3 | ($13,479) | $197,422 | 3 | $2,204 | $28,620 |
| 4 | ($12,986) | $233,087 | 4 | $2,436 | $31,665 |
| 5 | ($12,481) | $270,476 | 5 | $2,673 | $34,802 |
| 6 | ($11,963) | $309,674 | 6 | $2,915 | $38,034 |
| 7 | ($11,432) | $350,768 | 7 | $3,161 | $41,363 |
| 8 | ($10,888) | $393,850 | 8 | $3,412 | $44,796 |
| 9 | ($10,330) | $439,016 | 9 | $3,669 | $48,334 |
| 10 | ($9,759) | $486,366 | 10 | $3,930 | $51,983 |
| Final Value | $80,112 | ||||
| Final Value | $364,658 | x5 Units | $400,558 | ||
We can see that the cash flow investor is ahead by nearly $50,000 after 10 years! That is significant given that we only started with $100,000. Chalk up 1 point for Cash Flow Investing. Of course, appreciation is most powerful when it can compound, so let’s continue to year 20:
| Appreciation Investing | Cash Flow Investing | ||||
| Year | Cash Flow | Equity | Year | Cash Flow | Equity |
| 1 | ($14,429) | $130,953 | 1 | $1,753 | $22,791 |
| 2 | ($13,960) | $163,403 | 2 | $1,976 | $25,663 |
| 3 | ($13,479) | $197,422 | 3 | $2,204 | $28,620 |
| 4 | ($12,986) | $233,087 | 4 | $2,436 | $31,665 |
| 5 | ($12,481) | $270,476 | 5 | $2,673 | $34,802 |
| 6 | ($11,963) | $309,674 | 6 | $2,915 | $38,034 |
| 7 | ($11,432) | $350,768 | 7 | $3,161 | $41,363 |
| 8 | ($10,888) | $393,850 | 8 | $3,412 | $44,796 |
| 9 | ($10,330) | $439,016 | 9 | $3,669 | $48,334 |
| 10 | ($9,759) | $486,366 | 10 | $3,930 | $51,983 |
| 11 | ($9,173) | $536,007 | 11 | $4,197 | $55,746 |
| 12 | ($8,572) | $588,050 | 12 | $4,469 | $59,628 |
| 13 | ($7,956) | $642,610 | 13 | $4,747 | $63,634 |
| 14 | ($7,325) | $699,810 | 14 | $5,030 | $67,768 |
| 15 | ($6,679) | $759,777 | 15 | $5,318 | $72,036 |
| 16 | ($6,016) | $822,646 | 16 | $5,613 | $76,443 |
| 17 | ($5,336) | $888,557 | 17 | $5,913 | $80,994 |
| 18 | ($4,640) | $957,656 | 18 | $6,220 | $85,696 |
| 19 | ($3,926) | $1,030,099 | 19 | $6,532 | $90,554 |
| 20 | ($3,194) | $1,106,048 | 20 | $6,851 | $95,574 |
| Totals | ($184,525) | $1,106,048 | Totals | $83,019 | $95,574 |
| Final Value | $178,593 | ||||
| Final Value | $921,523 | x5 Units | $892,964 | ||
Okay, now we’re talking! “Get some!” sayeth the Appreciation Investor. We now show the appreciation investor ahead of the game by around $30,000 after 20 years. After 20 years, that’s not much. Quite anticlimactically, they’re basically the same results. Or are they? Let’s consider what you did for the past 20 years. As a cash flow investor you are probably not sitting still. You are expanding! You have positive cash flow that meets every bank’s wet dreams 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 or 9, then 11 or 12… you see what I’m getting at? The appreciation investor can pull out equity using a LOC or a cash-out refinance, but how many properties can they buy at a loss of income for each one? How many banks will finance that? The only real exit strategy becomes selling the property to reinvest the proceeds into a different type of asset. Into what? Who knows, but unless they have a very high other income job/business/pension/trust fund they cannot afford to scale up their losses. This type of investor had better hope there is no downturn and loss of 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.
There is a bright spot for the appreciation investor here: only 1 unit! The external happenings and time requirements are far reduced when you have 1/5 the number of units: 1/5 the furnaces, A/C units, water heaters, and tenants. My personal investing strategy would say that the constant fear of an injury, loss of job, market downturn, expensive eviction, or anything else is a much larger headache in my world than what you get from more units, but that is me and I am not the same as everyone else.
Okay, this was pretty long, but I wanted to get some numbers out there. To be honest, before I ran the numbers 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 about their market and their timing, 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 align with your goals. Until next time, best of luck and happy investing!