Is it Better to Invest for Cash Flow or Appreciation?

How much equity have I built up in my rental properties?

I have more than $5 million in equity in my commercial and residential rental properties. I have been lucky that the real estate market is on fire, but I have also created a lot of that equity as well by forcing appreciation. Forcing appreciation means you add value by making repairs, adding income, or getting a great deal. 

A lot of people will say that I bought at the right time and it is impossible to build equity when prices are high. Well, I am still buying and buying more now than ever. One of my best deals was bought in 2018 where we created more than $2 million in appreciation with one property and it was almost all forced appreciation, not the market increasing. This was a commercial property where we added tenants and had the leases increasing on NNN terms. We also got a smoking deal on this property and you can use that equity as well which we will talk about soon.

How much cash flow do my properties have?

This is a tricky question for me because I buy many value add properties that may be vacant. I have a lot of expenses from those properties that eat into my total cash flow while we stabilize them. I also use private money to buy many of them which is expensive until I refinance the property with banks at lower interest rates.

Right now, I bring in around $20,000 a month in cash flow which is pretty low considering the equity I have in the properties. That is only about a 5% return on the equity, but remember I did not spend that much money to buy the properties. In total, I have probably spent less than a million dollars buying everything which means I have a 24% return on my investment.

When I stabilize all of my properties my cash flow should be closer to $40,000 or more a month. Of course, by that time I will have bought more value add properties that will reduce that cash flow as well. I am addicted to buying real estate! Even, if I had $40,000 a month in cash flow now, that is $480,000 a year in income, it would take me a long time to save up that money to equal the equity gain. The equity gain has also created more cash flow for me! 

How can you sell rental properties (1031 exchange) to create more cash flow?

Having a lot of equity in real estate looks great on paper, but it does not do you much good in the real world. Luckily there are ways to take advantage of that equity. Refinancing properties, obtaining lines of credit, and selling houses are ways to tap into that equity. I am actually selling some of my rentals to create more cash flow. 

I sold rental property number seven for $370,000 a couple of months ago after buying it for $107,000 in 2013. I got an awesome deal on that home and it has increased in value greatly. After making repairs, and selling costs I made about $240,000 on the home and that does not include the cash flow I made every month, or the loan pay down, or the tax advantages.

I sold that rental and used a 1031 exchange to buy another rental for $510,000 that will produce much more cash flow. I used a private loan to buy that one and about $220,000 from the sale (I had less proceeds than profit because I refinanced this property once and my loan is more than the purchase price when I sold it). 

The old property rented for $1,600 a month although market rent is closer to $2,000 a month now. The new property rents for $2,500 a month but has the potential to rent for $5,000 a month after adding a couple of apartments and raising rents! The new property will also be worth $900,000 or so once we do all of that. It might take $100,000 to make the repairs and some time to raise rents but it will be well worth it. 

I have completed 2 other 1031 exchanges and I am completing another right now! All of these can be found on my YouTube channel. The more equity you have in properties the better properties you can buy when using the 1031 exchange. 

How can a refinance increase cash flow?

Another way to tap into the equity on rental properties is to refinance them. A refinance is when you place a new loan on the property that replaces another loan. You can use a refinance on a property owned free and clear as well even though you aren’t technically refinancing it since there is no other loan to replace. 

On the big property I talked about at the beginning of this article, we bought it for $2,100,000 in 2018. In 2019 we had it appraised for just under $4,000,000. We financed the property with a loan when we bought it of $1,575,000 and the new loan with the refinance was about $3,000,000! We were able to pay off the old loan, pay the costs for the new loan, and keep the rest of the money as a tax-free equity pull. 

Getting a bigger loan on properties does not increase the cash flow, in fact, it may decrease the cash flow since the payments could be higher with the higher loan amount. However, I can take that money from the cash-out refinance and use it to buy more rentals that have cash flow and overall I increase the cash flow on my portfolio. 

These may seem like some big numbers that are not relatable, but I have done much smaller cash-out refinance as well and the video below goes over the numbers on those. 

Is cash flow or appreciation better?

The answer to this question depends on how you invest in rental properties. Some people pay full retail value with cash flow. Any appreciation they have is only market appreciation. If you are only betting on market appreciation cash flow may be the most important aspect of your investing strategy. 

I like to always get a good deal on my properties which means I am forcing appreciation and gain equity as soon as I buy. Cash flow is not as important in these situations because you have a built-in safety net. However, I still like to buy properties that cash flow. 

If the market changes or prices drop it is vitally important that your property still makes money. Most people who lost everything in the last housing crash were buying rentals with little cash flow and hoping prices went up. They also failed to force appreciation. 

Now, if you have plenty of cash and are looking for big hits, appreciation is the play to go with knowing if the markets change, you may have to sink some money in the properties until things improve. 

If I had to choose one option I would say appreciation, forced appreciation is the best strategy because you can create cash flow with the equity ad build wealth faster. 

Conclusion

There are a lot of things to think about with appreciation and cash flow. One issue is that some markets are hard to cash flow in! Luckily, if you are able to force appreciation you can often cash flow in those markets as well. If it is simply impossible to cash flow and you want to own in expensive areas make sure you have plenty of cash reserves in case things do not go as planned!