Appreciation Vs. Cash Flow - Do You Have to Choose One?
Renters Warehouse Blog
When it comes to investing, you’ll want to ensure that you’re making a profit at the end of the day.
But what type of profit, exactly, do you want to be making?
When it comes to investing, the bottom line is to make money and get a good return on investment. This can be done in one of two ways; in the form of cash flow or appreciation. The question is, is one better than the other? And do you have to choose just one?
The truth is: that depends! On what your investment goals are, and which one will help you to reach them faster. In this article, we’ll take a look at some things that you should consider when it comes to investing for appreciation or cash flow. See which one’s best for your needs.
Investing for Cash Flow
First up, a look at cash flow. When it comes to rental properties, cash flow is often considered to be king. and for good reason.
Cash flow accounts for the difference in your property’s income and expenses. If you have “positive cash flow” it means that your income is greater than your expenses. And let’s face it, most investors want to be cash-flow positive.
When it comes to cash flow investments, many investors aim to find a property that will give them a certain percentage back in cash flow. That percentage will vary from investor to investor and will depend largely on your own goals and investment criteria. It’ll also depend on how aggressive your investment strategy is. For instance, if you’re looking for a property that’ll produce primarily cash flow, then you may want to have a more aggressive investment strategy and only look for properties that produce 10-15% cash flow returns. But if you’re looking to invest in properties for both cash flow and appreciation, then you can afford to be a bit more flexible with your cash flow returns, since you’ll be getting appreciation as well, and that should factor into your returns as well.
Now, let’s take a look at a few benefits of investing for cash flow.
Advantages of Investing for Cash Flow
When it comes to investing for cash flow, there are a number of different aspects that you should consider. Here are a few of the main reasons why cash flow is considered king by many investors.
- It Can Serve as Passive Income – Cash flow is important for the here and now. It can help you to cover your expenses, and when done right, will serve as an extra source of income: even passive income. While one cash-flowing property might not make you wealthy, having two or three can certainly help ease some of your expenses. The more properties you have, the more monthly income you’ll be able to generate. Check out The Most Time-Consuming Aspects of Being a Landlord to see how you can minimize the work that’s involved with managing rental property.
- More Security Incase of Economic Downturns – Investing in a property for cash flow can give you added security as well. In case the market was to experience a sudden downturn, your cash flow would most likely be minimally affected.
- Easier to Get a Loan – Another benefit to investing for cash flow is that it often makes it easier to acquire a bank loan for an additional property. This is because your cash flow will count toward your income, which banks will want to see before they give you a loan.
Risks of Investing for Cash Flow
So what’s the downside to investing for cash flow? Not much! Investing for cash flow is very low-risk, and offers you a good opportunity to start generating passive income. Here’s a look at a couple of risks to watch out for:
- Not Calculating Your Returns Accurately
One risk when investing primarily for cash flow is that you may end up not calculating your returns accurately. Make sure you factor in all of your expenses when running the numbers.
- Losing Money
Success with cash-flow properties involves finding a good tenant. So make sure you have an airtight tenant screening process in place when sourcing tenants. And avoid these common tenant screening mistakes.
- They Can Be Difficult to Find
Finding an investment property that will give you positive cash flow at a good price can be difficult. For this reason, it’s often a good idea to cast a wider search net and look for properties that are in a different market, an area that tends to produce properties with a better rate of cash flow.
Tip: It’s also a good idea to consider finding a value-add property, one that needs some work. This could allow you to obtain a property for a better price, meaning your returns will be higher as well.
Read How Much Cash Flow is Good for a Rental Property? For more information on finding a good cash-flow property for your investing purposes.
Investing for Appreciation
Next up, we have appreciation. Something else that investors often look for. The great thing about appreciation is that it can help you to grow your wealth for the future.
Appreciation is the increase of a property’s value as time goes on. A property will almost always naturally appreciate over time, but how much depends on a lot of factors, the main one being the housing market. You can help to increase the value of your property too by looking for a value-add property, one that’s in need of repairs or renovation, and doing work to it. Appreciation is an important part of investing because as time ticks on, your appreciation will (ideally) increase. Investing for appreciation is more of a long-term strategy.
But should it be the only strategy that you employ? In most cases no. Investing in real estate for appreciation alone can be risky if it’s your only return. In most cases, a blend of cash flow and appreciation is a safer strategy.
Advantages of Investing for Appreciation
Here are just a few of the reasons that many investors choose to purchase a property with a look at long-term appreciation.
- Tax Breaks – Appreciation is only realized once you sell the property. At which time you’ll want to avoid having to pay excessive taxes if you can. If you are buying a property for appreciation and planning to sell and roll the profits to roll into another investment, then there could be some tax benefits available to you. A 1031 exchange allows you to defer taxes on real estate sales, helping give you a break come tax time.
- Potential for a Faster Profit – In some cases, you can make a quick profit with appreciation. For instance, if you decide to go with a fix and flip, where you buy a property with the plan to fix it up and sell it quickly, you have the potential to make a nice profit in less time. Keep in mind though, that this is a more risky strategy than investing for cash flow. A better option would be to look for a property that would do well as either a fix-and-flip or a rental. That way, if the market’s not doing well when it’s time to sell the property, you’ll have options. You could potentially tap into cash flow by renting the property out while you wait for the value to go back up before you sell.
- Long-Term Wealth – Another benefit of investing for appreciation is that if you take the long-term approach, you’ll have the added security of knowing that you have a solid asset in your portfolio, one that’s very likely to increase in value considerably over the years ahead. While the process might not be quick, it’s a steady way to save for the future and can also be a great way to hedge against inflation.
Risks of Investing for Appreciation
Of course, when it comes to investing for appreciation there are risks you’ll want to take into consideration when weighing up your options.
The Risk of Betting on the Market
Perhaps the biggest disadvantage to investing for appreciation is the fact that you’re betting on the market. Of course, if you look at property nationally over the long-term, it’s appreciating steadily and has done so for decades. There are times of economic downturn where the prices go down, but they always recover and then continue their steady march upwards. The risks when investing for appreciation, come when you’re trying to time the market in the short term. So let’s say you were planning to resell in a few months, or even 3-4 years’ time. That adds a level of risk to the equation. But if you’re in it for the long-term, your level of risk goes way down.
The Risk of Missing Out on Cash Flow
One more risk when investing for appreciation is that you’ll neglect cash flow. Something that can make it harder for you when it comes to your day-to-day expenses. Of course, if you already have investments or you have a great job and can afford to go without the cash flow, then this isn’t an issue, but don’t make the mistake of focusing on future appreciation if you’re in need of funds in the short-term as well.
Investing for Cash-Flow and Appreciation: Things to Consider
So we’ve seen some of the benefits of cash flow and appreciation, now the question is, do you have to invest for just one or the other? Or when it comes to rental properties, can you invest for both? While you could do primarily one or the other, and many investors do, however, investing for both is a strategy that gives you the best of both worlds.
When investing for appreciation, you stand to make more long-term, however, you’re sacrificing the potential returns that you could have been generating with a cash-flow positive property. Additionally, if you’re depending solely on appreciation, you could be disappointed should the market head south for a while. If you have a property that’s producing cash flow though, you’ll be able to ride out any temporary downturns in the market because your property will still be generating rental income, no matter what the market is doing. You can continue to rent it out even during times of economic uncertainty, making it a bit easier for you to bide your time and wait for the market to recover before you sell.
Now, here are a few more things you should consider if you’re looking for both cash flow and appreciation.
- The Market
When it comes to investing, the market that you choose to invest in will have a big impact on the type of returns that you generate. That’s because generally speaking, properties in specific markets tend to generate better cash flow, and in some markets tend to experience stronger rates of appreciation.
So can you invest for both? Yes! You’ll just need to be very specific with your goals, your investment criteria, and when it comes to the market that you invest in. In most cases, you’ll find that strong cash flow markets can be found in places in the Midwest or small towns. In some of these areas, properties just don’t appreciate that fast. But you can usually find good, cash-flowing properties there. It just depends on what you’re looking for.
So what about appreciation? Once again, some markets appreciate better than others. Take for example properties in hot markets. These locations always seem to be experiencing strong property growth. (They also tend to approach bubble territory sooner than the rest of the U.S., so exercise caution when investing in these areas).
Okay, so what if you’d like to invest for both cash flow and appreciation? The good news is you can! There are a number of markets out there where you can indeed experience cash flow and appreciation. Your best option is to try to spot an emerging market –a place where property values are climbing, and that’s expected to experience job and population growth over the next few years. You’ll want to look for signs of strong economic development –like an Amazon distribution center that’s being built nearby.
- The Property
Next, the market is important but the property that you purchase matters too. So how can you find a property that’s expected to experience both appreciation and cash flow? By running the numbers. Once you have a potential property in your sights, take the time to calculate its returns. Take a look at websites like Trulia and Zillow to see what other, similar properties in the neighborhood are renting for. Then take a look at appreciation. Try to go back at least ten years to get an idea about what the average rate of appreciation is, and what it’s likely to do. Then factor in all of your expenses, and subtract them from the total to see what your cash flow would be.
- Your Motive and Investment Goals
Before you buy your first property, it’s a good idea to sit down and think about what your big-picture goals are. Why are you investing? What is your plan? Having your goals and plans laid out can help to guide your decisions when it comes to cash flow versus appreciation. For instance, if your goal is long-term wealth creation, then you’ll want to invest in properties that are likely to appreciate. And if your plan is to create passive income streams, then you’ll want to look for cash-flowing properties.
See how you can Create Wealth Through Buy-and-Hold Investing
And if you’re looking for a fixer-upper, you should also be sure to run the numbers and make sure that all the repairs that are needed will still leave you coming out on top.
Keep in mind that at the end of the day, you can choose both. And as you grow your portfolio, you can further diversify your holdings as well. Maybe you’d like to start out with a property that’ll give you both cash flow and appreciation. Then as you add to your portfolio, maybe you’d like to look to add a few strong cash-flowing properties, and a few properties that you’re investing in for long-term appreciation as well. You don’t have to choose just one or the other. Having some cash flow can help you reach your short-term, more immediate goals while investing for appreciation could help get you set up for the future.
When it comes down to it, investing is all about what you are hoping to achieve, and your goals both for the here and now and in the future. The best investment strategies usually involve a short-term and long-term outlook, and often, that means looking for both cash flow and appreciation.
Still, the right strategy for you will depend on what you’re looking for, so make sure you take your goals into consideration when choosing a property and deciding what type of returns you’re looking for. Then, conduct some market research to find an area that has properties that fit your criteria, and be sure to run the numbers to find a property that will give you the returns that you need.
Are you looking to get started with rental properties? Take a look at Tips for Spotting a Good Investment Property. Find a property that’ll generate the type of returns that you’re looking for!
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