Forget being stuck between a rock and a hard place. How do you choose between a pillow and a soft place? Two great options is a fantastic problem to have, but it’s still a question to be answered.
The main benefits of real estate investing are cash flow and appreciation. Both grow your wealth, so how do you choose which to actively pursue? Let’s look at these different measures of real estate performance so you can understand the differences and decide which to prioritize.
Understanding Cash Flow
When you own rental property, you get paid in the form of rent collected. After you subtract all expenses, the net remaining is your cash flow. For example, if a property pays you $2500 in rent and you owe $1900 expenses (ie., mortgage, HOA, repairs), your property is generating a positive cash flow of $600 per month.
When cash flow is your priority, you select your rentals based on the projected income compared to the projected expenses. The larger the differential, the higher the cash flow.
Most long-term investors prioritize cash flow. It provides money for them to live on, like a monthly paycheck. This income is also highly desirable because of its liquidity. You can quickly access the funds to readily use them for whatever needs arise.
Cash Flow Provides Options
You may also consider reinvesting some of that cash flow back into the property, making changes that can increase the cash flow even more over time. A kitchen update or a bathroom addition will temporarily eat into the cash flow, but it may allow you to charge significantly more rent when the renovations are complete.
Another option is to put the cash flow towards a down payment on a second rental property. These scenarios will both increase your cash flow, allowing it to grow even faster than the average rate of rent increases.
Cash Flow Increases Over Time
Because rents rise over time, cash flow typically does as well. Your rental that brings in $2500 each month in rent today could be getting $3000 per month just two or three years from now. And since many of your costs like the mortgage payment are static, your cash flow increases.
Paul Smith, executive director of the Utah Apartment Association, notes that rent went up in Utah by 12-15% in one year. While the increase is not always this high, those who owned rental properties over the past year, saw a marked increase in the cash flow on their properties.
However, during a down market, you might temporarily have negative cash flow, where your expenses are more than your revenues. That can also happen if you have a significant repair expense or are between tenants. A well-selected rental property should see very few periods of negative cash flow, but it is something to keep in mind.
Cash Flow Can Provide Freedom
Investing for cash flow can also allow you to cut back on work hours, upgrade your lifestyle, or retire earlier because you have additional income outside your employment or other businesses.
Appreciation is the difference between the purchase price of a property and the current value. If you bought it for $300,000 and could sell it now for $350,000, you have $50,000 in appreciation.
When investing for appreciation, you are playing a much longer game. Your money may be tied up for years before seeing a substantial gain. However, that gain can be quite significant when it comes.
Because you can only tap into appreciation via a home equity loan, line of credit, or by selling the property, your money is illiquid. That means it takes time to access. To access your $50,000 in appreciation in your property, you would have to sell the property. Depending on market conditions, selling could take weeks or months.
Appreciation Comes With Risks
Appreciation is more speculative than purchasing for cash flow. You can have good reason to think the value of a stock or a specific home may increase significantly over time, but there is no guarantee.
With appreciation-minded investment properties, you may face the possibility of temporary losses during down markets. Fortunately, the value of properties almost always increases given enough time, but you need to be prepared to wait out any dips in the real estate market. You can think of appreciation investing like owning stocks. The value may be down on any given day, month, or even year. But over time, you make money.
However, in many cases, this risk can be worth it. Real estate appreciation can generate significant wealth over time. That makes it an excellent option for generating substantial wealth longer term.
Appreciation Builds Generational Wealth
If you want an investment you can leave to your children to set them up for life, real estate appreciation can be a reliable way to do that. It can also help you retire. If you invest early in your career, cashing out on equity built through appreciation can put enough into your retirement coffers to allow you to pull the trigger on quitting.
Thankfully, when you invest in real estate, you will see both cash flow and appreciation. Your priority will drive your selection of investment properties. If you need assistance finding the best properties to maximize both forms of growth, residential real estate investment companies are experts in local markets and know what neighborhoods and types of homes see the best returns. They can help guide your choices and provide additional insights and services, which can be especially valuable for novice investors.