There is a raging debate between investors buying cash flow properties and investors buying for appreciation. I figured now is a good time to toss my hat into the ring and take a position which I think is better. Let me tell you what my thoughts are on what cash flow and appreciation investing mean to me. When I think of cash flow properties, I am thinking of properties that are yielding 10% or greater. Typically, they are not A class or seldom B class areas. The price range on a property like this is greater than 50k. (I struggle with the economics of Cap-ex on really low cost properties)
When I think of appreciation investing, I think of zero to negative cash flow properties, where the only goal is to see the price of the property go up through no effort of the owner. This excludes buying distressed properties and stabilizing them. This is buying a property and saying this property is going to go up in value because it is located here. These are typically in better neighborhoods with much higher price points.
As you can probably tell from the title of my post, I think cash flow investing makes more sense for a budding real estate investor. There are a few reasons why I think this.
Cash Flow Property’s Advantages
Let’s start with the first reason i.e. cash flow. Cash is king and always has been! Fundamentally, cash flow properties provide cash when all expenses are paid. From the beginning of time, the goal of a business has always been to generate cash. Owning a piece of investment real estate is a business in itself and I think it should be treated as such. Until more modern banking, there were not many opportunities to borrow money for a business. The business generated cash for the owner, his employees and his supplies. The excess cash was used by the owner to expand business. If the business could not make a profit, it went out of business. Period.
Cash is the life blood of a business. If you buy a property right, and the cash flow is realized, then it should keep you out of most trouble. It is a slow and steady way to make money. Just like a business was back in the day.
I can’t pinpoint the exact time this changed, but there has been an evolution. Business owners are no longer creating a business which makes money but a business which can eventually be sold to get their perceived value out. This is an enormous change. Some businesses now survive not because they are profitable, but because they can issue more stock at higher and higher valuations or because they can add more and more debt.
The “value” of the business comes from the rapid expansion fueled by inflows of cash from equity investors trying to catch the next wave up. This is how I see buying for appreciation. The business only survives because you are willing to put more and more money into the business with the expectation of a big payday when you sell the business to someone else. If you had a constant stream of investments coming in, you too could have rapid growth and expansion which then creates this so called “value.”
I also like the lower price point of cash flow properties. The reason I like this is because of the affordability in a general sense. If you have been looking at the news, more and more ridiculous prices are starting to pop up all over the place. So and so wants to sell their chateau on 1000 acres for $75 million. Great, there are 100 people on the planet that can afford to buy that. Should there be an economic crisis, that price cannot stay at that level. The bigger they are, the harder they fall.
But how far can the price of a $75,000 property fall? The mortgage for a property like that is around $350 a month. That is very affordable. I look at it as it keeps a floor for how far prices can fall, unless there is a dramatic decrease in incomes (well beyond the scope of this article).
As I touched on in the first point, I think expectations of a 10% price appreciation on properties are unsustainable. The whole business model is based on the greater fool theory. Think about this in really basic terms: for every seller there needs to be a buyer. So, for the price to go up what needs to happen? There needs to be a greater demand for that object. That demand has to have money behind it, whether its cash or debt.
Wages for the bottom 90% in the US have been stagnant since 1999. Existing home sale prices since 1999 are up 66%. This gap cannot continue to grow forever. At some point, wages need to rise significantly or prices need to drop.
When I think of real estate investment, I try to be conservative with my approach. Can you make millions by catching the upswing in the market holding a bunch of negative cash flowing properties? Sure, I’d rather be lucky than good, but I am not going to make a bet that luck is going to happen. I’m a grinder. I look to find that edge, whatever that is and exploit it over and over rather than take a big shot. It probably will be a slower path to wealth buying cash flow properties, but there will be significantly fewer bumps along the road.
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