Is it better to have cash flow now, or appreciation later? A recent trip to Palm Springs, CA got us thinking about how cap rate markets compare, and whether it’s worth buying into a lower cap rate market for the promise of greater appreciation down the road.
Comparing Two Markets
Much of California has historically been a lower cap rate market than areas like PA and MD. To answer the question, we ran a cash flow comparison between two hypothetical $1,000,000 multifamily purchases: one in Harrisburg, PA (population 651,000, part of a 13 million-person state), and one in Palm Springs, CA (population 511,000, part of a 39.5 million-person state). The PA property generates an NOI of $70,455, compared to $54,602 for the CA property, so the Pennsylvania deal produces meaningfully more cash flow from day one.
Cash Flow Now vs. Appreciation Later
The tradeoff shows up over a 10-year hold. Rents are forecasted to rise 4% per year in CA, compared to 2% in PA, and both properties are modeled to sell at the same cap rate they were purchased at in PA (7% in, 7% out) while the CA property compresses further, from a 5.5% purchase cap to a 6% exit cap. On the surface, the CA property’s larger rent growth and appreciation look like the stronger play. But the real comparison has to account for the time value of money: the extra cash flow the PA property throws off early can be reinvested and start earning a return right away, while the CA property’s advantage only shows up at the end of the hold.
What the Numbers Actually Show
Once you discount future appreciation back to today’s dollars, the gap narrows considerably. The present value of the CA property’s extra future growth works out to roughly $63,045, the difference between a discounted value of $134,439 and the PA property’s $71,394. It’s easy to look at the CA property’s projected exit value of $652,384 against the PA property’s $391,434 and assume California wins outright, but that ignores how much sooner the Pennsylvania cash flow lets you reinvest and compound returns. This example assumes an 8% average return used as the discount rate for the earlier Pennsylvania cash flows.
Why Local Markets Often Win
Real estate is local, and that’s often the deciding factor. California’s higher population growth rate, forecasted at 1.20% annually versus Dauphin County’s 0.37%, is part of why analysts assume stronger rent growth there. But population growth assumptions can shift quickly if residents decide the heat, fires, or earthquakes aren’t worth it, while a steady market like Central PA keeps producing dependable, if less dramatic, growth.
Curious how these cap rate dynamics stack up against the pressures we’ve been tracking in the market this year? Call us to discuss the best path forward for growing your NOI, wherever you’re investing.
