SS32: Buying Real Estate For Appreciation vs Cashflow

Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing buying real estate for appreciation versus cash flow

Watch The Episode Here:

Listen To The Podcast Here:

Talking Points:

First, let’s define the two terms:
– Appreciation: This comes about as a result of growth in the underlying property in which you own equity.
– Cashflow: This is when you receive income for renting out your property that exceeds all of your expenses and taxes.

As far as what experienced real estate investors focus on the most, the most common answer is neither. Instead

– Internal Rate of Return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments.

It excludes external factors (hence the name internal), such as the risk-free rate, inflation, the cost of capital, and financial risk, and instead applies a discount rate to (attempt) to determine the annual rate of growth that an investment is expected to generate.

How to Calculate IRR
– Let’s assume the property costs $100,000 to keep things simple and that it will generate $12,000 annually after tax and grow by $6,000 for each of the next five years. In this case, the IRR would be 18%.

– While these are and will always remain best guesses, the more experienced you get, the more realistic your projections will end up being.

Why IRR?
– Experienced investors are interested in knowing how much and how soon so that they can compare the potential return to other available opportunities.

We Focus on Cashflow:

Very easy to estimate future returns – rents normally do not decline – expenses will usually increase at or just above inflation
For example, $2,000 monthly payment – $2000 taxes, principle, interest, insurance – the biggest part of that principle and interest will not be increasing – taxes will most likely not increase in a pullback, and insurance, common utilities may only increase by a few percent – if your insurance portion is $2000/year and it goes up by 5% – that is a $100 annual increase
With an appreciation-only strategy – what happens when there is a pullback? Is the only way you make money when you sell? Costs to sell are usually about 10% – not counting income taxes
Remember the value of your property only matters when you; buy, sell or refinance – other than that, it is just a number on your financial statement
Focus on cashflow – a solid investment strategy to make money in – up, down, and sideways markets

We suggest that you also read episodes SS2 & SS3

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing buying real estate for appreciation versus cash flow. So in episode, [inaudible] I discuss buying properties and choosing target markets that will give you a mix of both cashflow and appreciation. But the day I want to dive deeper into both strategies. So appreciation comes about as a result of growth in the underlying property, in which you own equity cashflow is when you receive income for renting out your property, that exceeds all of your expenses and taxes. So one strategy to experience real estate investors focus on well, we’re going to focus on both of them using a metric called internal rate of return or IRR, which is used in financial analysis to estimate the profitability of potential investments. Now it excludes external factors, hence the name internal, such as the risk-free rate of return inflation and the cost of capital, but it allows you to compare two investment opportunities and know which one might be better suited for you and your capital.

Charles:
So how do you calculate the IRR? Well, very simply let’s assume that property costs a hundred thousand dollars and it’ll generate $12,000 annually and grow by $6,000 in value for each of the next five years. In this case, the IRR would be 18% while these are and will remain best guesses. The more experience you get, the more realistic your projections will end up being. But what strategy are we really focusing on? Well, we’re focusing on cashflow and the reason why we focus on cashflow, it’s very easy to estimate future returns with cashflow rents normally do not decline in a pullback rents will usually increase in a normal market or a growing market portion of the market cycle. And expenses will usually increase at, or just above inflation in either for example our monthly payment, which includes taxes, principal, interest, and insurance. The biggest part of that principal interest will not be increasing.

Charles:
If there’s any pullback taxes will most likely not increase because property values are most likely going down and insurance and common area utilities will only increase by a few percent. So if your insurance portion of your payment is $2,000 per year, and it goes up by 5%, that is at a a hundred dollar annual increase on $8 a month. And that’s easy to be spread upon new renters that you have coming in or current renters you have when you’re signing your next year’s lease with appreciation only strategy. And what happens when there is a pullback is the only way you make money is when you sell cost the seller, usually about 10% not counting income taxes. Now, when I’m saying that I’m including state county and city fees and taxes and everything like that, obviously we’re not talking even taxes. Any of this is just a fees with your agent usually comes to somewhere around 10%.

Charles:
So if you’re buying property for a hundred thousand dollars, that property has to go to 110 hundred and $11,000 just for you to break. Even after all the fees. Remember the value of your property when you’re investing for cashflow only matters when you buy, sell or refinance. Other than that, it’s just a number on your financial statement when you’re buying for cash flow. I like it because I can make money in an up, down and sideways market. It’s very difficult to make money when you’re buying for mainly or all appreciation in a market that’s going down or sideways unless you’ve purchased at a dramatic discount. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments, and potential show topics at global investors, podcast.com. Look forward to two more episodes next week. See you then

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar LLC exclusively.