Cash Flow Rentals Remain Resilient

In last week’s newsletter I mentioned the data is showing prices for cash flow rentals are holding up much better than real estate in markets that more heavily favor a play on appreciation. I realized that topic warrants a deeper look so I figured I’d do a post about it.

Every week I speak with dozens of real estate investors that are seeking to put money into markets that favor cash flow rentals rather than more speculative appreciation plays.

Many of these conversations are with people in San Francisco, Los Angeles, and Seattle. And they’re all weighing markets like Cleveland, Detroit, and (to a lesser extent) Memphis.

Naturally, I’ve been curious what’s happening with prices in these markets. Let’s take a look.

A Look at Appreciation Markets

Since most of my phone calls are happening with folks in Los Angeles, Seattle, and San Francisco those are the markets that made the most sense to look at on the appreciation front. And while it’s far from perfect I decided to use Zillow’s home price index for each city to get a general sense of how each market is performing.

Los Angeles

According to Zillow, the average Los Angeles home price was up 2.4% year-over-year through January 2023. But when we look at the historical chart you have to wonder how much longer home prices can print annual gains:

Prices appear to be rolling over.

In fact, home prices have actually been higher every January on this graph when compared to the preceding December. This is clearly a break in trend as Los Angeles home prices still seem to be searching for a bottom.

Seattle

The picture is similar in the Seattle market where the average home price is essentially flat on the year, up just 0.20%. The market topped in June of 2022 and is now more than 7% off the high:

It does seem that the Seattle market is starting to level out. Could we see a similar trend to what was happened in mid-2018 with prices topping out during the summer and not making new highs for nearly two years?

I don’t see why not.

San Francisco

The San Francisco market is by far the weakest of the trio. Home values are down nearly double digits, falling 9.2% year-over-year through January. The San Francisco market actually peaked a bit earlier than Los Angeles and Seattle in May 2022:

San Francisco has clearly been hit the hardest. The average home price now sits at $1.28MM, down over 12% from the high in May. But even more impressive is the fact that the average home price in San Francisco hasn’t change much since 2019.

I don’t want to speculate on why San Francisco is getting hit the hardest. It’s likely not just one thing but a combination of expensive housing stock coupled with higher interest rates, work-from-home culture being stickier than the media is leading us to believe (shocker!!!), the struggles of tech after a COVID-fueled run up, among other things.

All I care about here is that San Francisco was the first market to really start falling and it might be a good indicator on the other side of things when it starts to stabilize.

Cash Flow Rentals Are Benefitting

While markets favoring appreciation seem to be treading water, at best, cash flow focused markets are looking increasingly resilient. In fact, cash flow rentals may be gearing up for another leg higher in value.

Let’s take a look at three cash flow heavy markets.

Memphis

The Memphis real estate market has been a popular place for investors over the last few years. But the average home value is now nearly $150,000 and making it increasingly difficult to find cash flowing rentals.

I have been speaking with a lot of folks that had invested in Memphis and are now seeking new markets that make more sense.

While there’s been a bit of a slowdown in the Memphis market prices are still up 12.9% from a year ago (data through January 2023).

Is this unique to cash flow focused markets or is Memphis an outlier?

Cleveland

I have been hearing Cleveland getting talked about a lot more in the last 1-2 years. I touched on Cleveland a bit in my post about real estate markets with declining populations but increasing home values. I didn’t realize the population in Cleveland had been on the decline until I wrote that post.

Home prices in Cleveland are up a very strong 10.8% on the year. But what’s even more interesting to me is the tick higher we’ve seen since November.

Prices hit a low in November and have moved higher in both December and January. Will we continue to see new highs in Cleveland home values?

It’s sure looking that way!

Detroit

If you know me you know I absolutely love the Detroit market. It’s been exceptionally good to me and my family and I’ve been starting to share some of my rental performance.

Much like Cleveland, Detroit is seeing an uptick in average home prices as of January:

The market is up 7.1% on an annual basis but the average price is less than half that of Memphis and well below Cleveland.

I firmly believe we are still in the early phases of appreciation potential for Detroit as more people realize the city has suffered from an overly negative stigma.

Related Post: There are fantastic things happening in Detroit. Read: “Why Invest in Detroit? And Why Now?”

Cash Flow Reigns as Rates Rise

Inflation is still running rampant.

And while bonds and high-yield savings accounts are paying decent interest, most investors aren’t happy sitting on cash and losing purchasing power.

Instead, with elevated rates, investors are seeking cash flow rentals in areas they can still put money to work and have the numbers make sense.

And I have a feeling we’re going to see this play out for longer than folks anticipate. But for those that have been paying attention the popularity of these high cash flow markets is nothing new.

Heck, the average home price in Detroit has gone up more than 5.5x between January 2015 and January 2023!

I believe we will continue to see this trend of cash flow markets outperforming appreciation markets for at least the next couple years, perhaps longer.

And as that unfolds we’ll start seeing increasingly more people warm up to a city like Detroit.

Said another way, Detroit is the next Cleveland and Cleveland is the next Memphis.

What markets are you looking at that I didn’t cover here? This might be something I need to revisit every 6 months and I’d love to hear from you!