Would you rather have $100,000 or $100/month?

Posted by neil on August 23, 2010
General

Hi Everyone,

I hope that you are all doing well.

It has been some time since my last blog post.

I have spent some time enjoying the summer and travelling with my family.

Now that the summer is coming to an end here in Toronto, it is back to the ‘grind’.

Today I would like to talk to you a little bit about an age old debate that never seems to go away in the real estate investment world.  Quite frankly, this debate will never go away…

It is the debate surrounding:

Cash flow versus Appreciation.

More specifically, the question at hand is:

Is it better to buy investment real estate for cash flow or appreciation?

If you ask this question to any experienced real estate investor, who has been around for some time, and has invested in different stages of the market cycle, they will most likely tell you that they invest for cash flow.

I would like to turn this discussion on it’s head, and say that the most successful real estate investors are the ones that purchase for appreciation, not for cash flow.

When I first began my real estate investing career, I purchased for appreciation, simply because I did not know any better.  Purchasing for appreciation I thought was the only reason anyone would purchase real estate as an investment.

As time went on and I started to learn more about real estate, real estate investment, and the methods required in order to obtain financing on investment real estate, I started to buy for cash flow.

I started to buy for cash flow because I wanted to grow my real estate portfolio.

I wanted to buy property after property, and quickly discovered that I was only able to do this if in fact I purchased cash flowing properties.

Thanks to my amazing mortgage broker, Kevin Boughen, we were able to obtain financing on 4 properties within about a 2 year span.

As of August 2010, I have a portfolio of 5 single family residential homes.  3 of the homes I have purchased for cash flow, and the other 2 I have purchased for appreciation.

The largest gains in terms of equity appreciation that have occured have come from the properties that I have purchased for appreciation.

Today I was speaking with a very experienced real estate investor (who may be reading this).  Over the past 5 years, he has made 4 strategic purchases for appreciation.  After the 5 years, he currently still holds all 5 properties and has realized an appreciation gain of $500,000 from these 4 properties.

After a detailed discussion with him today, he really got me thinking.  Why would anyone buy for cash flow, when they could buy for appreciation and have much greater returns?

What do you think?

As a new real estate investor, should you buy for cash flow, or should you buy for appreciation?

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Best Regards,

Neil.

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8 Comments to Would you rather have $100,000 or $100/month?

  • Hey Neil, great post and question. When you’re buying for appreciation are you doing so with no regard to cash flow? Are you willing to have negative cashflow or simply break even?

    For me, I purchase for cashflow but at the same time I don’t buy in an area that I don’t believe will have long term appreciation. In my market, I actually have confidence in long term appreciation for almost every neighborhood simply because South Florida is a popular hot spot.

    I’m just wondering whether buying for appreciation (from your perspective) presumes zero or negative cashflow. The people who bought for appreciation only in South Florida were involved in a blood bath when our values declined 50-60%!

    • Hi Shae!

      Thanks for your comment and sorry for the delay response. I am getting back into the swing of things.

      I guess my observations are somewhat unique when compared to some other real estate markets.

      I have witnessed over about the last 7 years substantial equity appreciation in Oakville, Ontario, Canada. (aka my hometown)

      Investors with deep pockets here buy exclusively for appreciation, or at least they have been doing so over the past 8 years. They have purchased knowing that they would not cash flow the property at all, and that it would in fact be negative cash flow.

      Some of these investors have purchased multiple properties (all at a negative monthly cash flow) however, and have cleaned up in the appreciation department. (done very well)

      I have never witnessed any other real estate market like this. It is a market with no real industry. It is a higher than average income town located approximately 30 min away from Toronto. People who can afford it move to this suburb. The other interesting thing is that there is still a lot of land here, in which new homes are being constructed. It is one of the last areas in the Greater Toronto Area where there is so much land left to develop.

      Some of the really experienced and long time real estate investors in this community think that there is no end (at least any time soon) to the equity appreciation in this community.

      It is quite unexplainable to be honest.

  • Hi Neil,

    To answer the question begged by the title of your post, I’d rather have $100,000 which I’d use to buy real property that produces more than $100/mth cash flow.

    When looking for investments, my first priority is always to make sure the property will cash flow so I don’t have to “feed” it every month. If the property will put money in my pocket using the posted 5 year fixed rate, 5% for repairs and maintenance, 5% vacancy and all the monthly expenses, it gets my attention.

    Once I know the property is going to be a worthwhile asset, I consider how much cash flow it provides AND its appreciation potential. One is a little easier to predict than the other, but I’ve found there is often a trade off.

    Some areas have great cash flow but little appreciation potential. Other areas have great appreciation potential but poor cash flow which I consider risky. I like to find properties that have a good mix between cash flow and appreciation potential. As long as the cash flow is strong enough to weather the inevitable economic storms during a long term buy-and-hold, keep on buying!

  • Hey Neil –
    I buy for cash flow and plan for appreciation. Not to mention real estate investing is my job and if there isn’t cash flow I don’t eat, dress or have shelter so that’s a big one too. I can’t wear appreciation and I don’t think it has much flavour.

    Seriously – I think buying for appreciation is a dangerous game. That makes for more speculation than anything. Appreciation is a fickle mistress. You can’t count on her. Shae’s situation in South Florida is a prime example.

    Good market research will go a long way to ensuring you do enjoy appreciation over the long run but cash flow will mean that you can afford to hold that property until that day arrives.

    Welcome back by the way – I was starting to wonder/worry you’d given up blogging.

    • Hey Julie,

      I totally agree with you.
      And I love that quote by the way… “Appreciate is a fickle mistress. You can’t count on her.”

      Cash flow is essential with real estate investing.

      As an aside, one of these days I will have to share with you my observations on the appreciation in Oakville, Ontario.

      All the best, and I am definitely back and blogging!

      Neil. 🙂

  • Hello Neil

    I agree with Julie. Cash flow is what sustains every business and increases the value of your venture. Banking on appreciation is risky and one can get blindsided by sudden changes in the economy – ask me about Grande Prairie or just ask the folks in the U.S. However, of course, I would love to have appeciation, however, I buy for cash flow first.

    Positive cash flow will help you ride out the bad times in the market. However, one has to manage their tenants, collections and expenses to achieve positive cash flow.

    Ajay Sritharan

    • Hi Ajay,

      Good points and thank you for your comment.
      I would love to chat with you one day about the recent value roller coaster in Grande Prairie.
      All the best and see you soon!
      Neil.

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