Comparing ROI with appreciation

[Willyboy]

Good morning. As I have been doing extensive research on real estate numbers I find most investors would be interested in cash flow for reasons such as they need to be able to sleep at night if the economy slows down and possibly lose a job or whatever where they wouldn't be able to sustain an investment with lower ROI than normally desired and negative cash flow and I fully understand them.

However and here's my question for real estate specialists who are strong on numerical analysis.

If you had a big reservoir of cash that will allow you to absorb any shock in the market for an unlimited time where you would be able to pay for a big mortgage or even pay off the whole mortgage balance instantly and still have a big reservoir left on hand would it be better to buy a property with negative cash flow but with a great potential for future price appreciation or a property with positive cash flow but doesn't have a big appreciation potential? Which one would be more profitable when you liquidate the properties in the long term?

 

[Thomas Beyer]

Your question is answered in this REIN post about a hypothetical $1M investable. What is better: Cash-Flow or Maximum ROI ? http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/
http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/
What is better: pizza or pasta, fish or steak, vegan or omelette ?

 

[Matt Crowley]

I've been fascinated with this question Thomas and decided to run it through a little analysis for kicks.

For anyone interested, try changing the inputs in B3, C3, and D3 for different mortgage amounts.

Analysis: https://docs.google.com/spreadsheets/d/1UJy9liZY8e02gZGFR80nrqSJnY6wGubwoMhRROZkSBk/edit?usp=sharing

- The answer as far as I can tell is that scenario 2 and 3 are totally identical assets with scenario 3 on-half the size as scenario 2

Unleverage all assets:
- Scenario 1 has a slightly higher price to rent initially of 10.83 vs. 10.69 but this is balanced by a slightly lower asset turnover of 9.23% vs 9.36% for scenarios 2 and 3, making the ROE for all at 4.5% initially
- After 5 years, scenario 1 actually preforms slightly worse than the other two with 5.7% ROE vs 5.8%

Leverage all assets 75% LTV
- CF for all assets $0
- identical initial unlevered years to payback of 22.2
- Scenario 1 with slightly worse asset turnover ratio
- in 5 years, ROE for scenario substantially worse at 4.8% with scenarios 2 and 3 providing 5.2% (this is due to lower profit margin of scenario 1)

Leverage all assets 50% LTV
- all assets have identical levered years to payback of 33.3
- ROE for each asset falls to 3% during initial 5 years
- ROE for scenario 1 lowest of the 3 scenarios in year 5 with 5.4% vs, 5.6% of the other two scenarios
- Levered years to payback for scenario 1 is 18.5 years vs. 17.9 years for scenario 2 and 3


...so in summary there may not be a right answer to buy scenario 2 or 3 or both but don't buy scenario 1 because it is the worst.