Cash flow rental property investors often describe appreciation as “icing on the cake”.
Meaning it is nice to have, but shouldn’t be the main reason you invest.
I am chowing down on that icing and it is SWEET!
Why I View Things Differently
Appreciation isn’t a nice to have, to me it is the main driver of returns.
My goal is slightly different than most investors – I want to build long-term wealth, not live off cash flow as soon as possible.
All cash flow for the next decade or two will be reinvested to achieve the snowball effect of growing the portfolio. All appreciation for the next decade or two will be reinvested as well (for example through a cash out refi).
There are 5 components of return on rental properties – I don’t care where I get the returns as long as they are big. With a multi-decade timeline, leveraged rental properties are the best investment, and I believe the biggest part of those returns will be appreciation.
But I Don’t Chase Appreciation
Cash flow is the margin of safety.
Real estate is known to have huge swings – it is very likely I will have underwater mortgages one day. That is when you owe more on the mortgage than the house is worth.
I won’t panic though, it will only be temporary. Since I’m looking at it from a decades long view, I will wait it out.
How do you wait it out? With cash flow!
For a normal year, I want a 10% cash return. This is the margin of safety for when disaster strikes and I have to replace the plumbing or something major. I will need to bring in professionals to get it sorted out and I want it done right, so whether I’m looking for a septic tank cleaning in Colorado Springs CO service or new pipes being fitted, I want to make sure it is going to be done in the best and most efficient way.
What a contradiction – I invest in cash flow markets with the hope of big appreciation?
Bingo! That is how I manage the inherent risk of leverage. No need to gamble, going for a boring ol’ 25% yearly return is good enough for me.
2016 Actual Results
I have two properties. A 3 bed, 2.5 bath in Atlanta purchased 5.5 years ago and a 3 bed, 2 bath in Memphis purchased 2.5 years ago. Out of pocket I invested $44k combined.
For 2016 the returns were:
- $2,222 in cash flow (even with the rough year in Memphis)
- $2,039 in tax benefits
- $2,225 in mortgage pay down (my super-sophisticated term for amortization)
- $18,000 in appreciation!
I haven’t done my taxes yet, but I actually think I might show a loss in 2016. So all that cash flow is tax free, then some might be carried over to 2017. Yet I walked away with $2,222 more in the bank. Aren’t taxes great!
The equity news is even better. A year ago the portfolio value (equity) was $69k. Today it sits at $89k! I know stocks had a great year, but you aren’t going to beat that!
Here is Atlanta:
I made a slight change on how I determine the property value. I am now averaging the estimate found on Zillow and Redfin, then taking 95% of that for my estimate. Though I could always find a professional property valuer to get a pinpoint accurate value, for the moment it is not necessary. I’m not planning on selling just yet.
For the overall portfolio:
Nice big numbers aren’t they? Though if you are into things like IRR, NPV, and discount rates, you can get the entire spreadsheet here.
A 31% yearly rate of return on my portfolio! This is incredible considering my properties are passive investments without getting my hands dirty doing repairs or even collecting rent checks myself.
Although the scoreboard currently shows 31%, I expect that to come down to 25% when we progress through the entire real estate cycle.
One of the things that will help with the overall portfolio return is when my properties start cloning themselves. Right now my Atlanta property is 49% paid off, which is awesome until you consider there is $57k in equity that isn’t earning a return. This year I will access part of that equity to invest in another property. That new property (the clone) will be all upside with no out of pocket expense from me in 2017 (just the original $19k in 2011).
The caveat being – there will be zigs and zags. I’ll keep checking in on the portfolio value every 6 months, but won’t cry if I don’t maintain a 31% yearly return.
How did your rental properties do in 2016? If you don’t have any yet, what is holding your back from getting the snowball rolling?