If you are looking to start investing in real estate, you may be confused about whether to invest for appreciation or cash flow. As a real estate investor, it is important to understand that no strategy is better than the other. Both have their benefits and drawbacks and both are valid approaches when evaluating a real estate trade.
With the current pandemic, many investors had to deal with negative cash flow while property appreciation rates have gone up. So should you invest in cash flow or appreciation?
Real Estate Cash Flow Investment
A cash flow strategy involves an investor receiving an immediate return on their investment, depending on market conditions and other factors.
In simple terms, cash flow is the difference between the income and the total expenses from an investment, typically on a monthly basis. For example, if you have rented out an apartment, a house, or a multifamily property, and you earn $2,500 in rent and your expenses are $1800, your cash flow from the above investment would be $700 each month.
However, in the current market, it is more difficult to find cash flow positive properties because prices have risen tremendously. In many markets, you can find properties that only cover their operating costs (cash-neutral) and for some properties investors have to pay out of pocket for maintenance (cash-negative).
In addition, cash flow also depends on the market conditions and the quality of the tenant. If there is a real estate market bust, your cash flow will take a beating. Bad tenants will also cause you to lose money.
However, if you do have cash positive properties, you may also benefit from appreciation. With enough equity accumulation, you can sell, refinance or use positive cash flow and accumulation to buy a new property.
In many cases, though, things are not as simple and you need to choose one or the other. You can have high cash flow if you buy a property in a low-cost neighborhood and upgrade it. On the flip side, in developed cities like Washington DC and San Francisco, it may not be so easy to find cash flow investments and you will need to rely on appreciation.
Why You Should Opt for Cash Flow
If your objective is to benefit from passive income while you reduce your work as a doctor or other professional to spend more time doing the things you enjoy, then cash flow investment may be the right choice for you.
The biggest advantage of cash flow is that you can get cash on an immediate basis and use it to reduce your clinic/ hospital time. Your income from property remains steady over time and you can continue to drop your private clinic hours to find a level of income that will still be able to match your lifestyle.
Depending on your individual investments, you could reduce 30% of your clinical hours. For some, this approach may not work at all.
Although there is no 100% guarantee for any real estate investment, cash flow investing does allow you to get some early returns, which can create a hedge against cash flow issues later on. However, you still need to carry out due diligence and find the right rental properties with a good potential of return by understanding the neighborhood, types of renters, and other factors.
A simple way to find out how your cash flow model is working is to buy a property a year and see how your cash flow snowballs in 5 to 10 years. Other investors may be more interested in buying multifamily properties to scale up quickly.
Doctors and other high-income professional may be more interested in buying multifamily properties to scale up quickly and generate income equal to or exceeding their professional income in a relatively short period of time.
Cash flow from rental properties also offers you versatility. Instead of following the traditional long-term rental approach, you can place your property on a listing like Airbnb for shorter duration rent-outs. You can also generate a good cash flow by renting out a portion of your house, a technique known as house hacking.
On a bigger scale, you could create a portfolio of both single family and multifamily properties to earn a passive rental income.
If you have purchased a property with a mortgage rather than buying it outright, your cash flow will grow over time as you pay off your debt and build more equity.
Real Estate Appreciation Investment
If you think real estate will increase in value over time, you should invest in real estate for appreciation. You may have reasons to believe that the home values in your neighborhood will increase or you intend to upgrade your property before you sell it.
On average, the average real estate appreciation rate in the US has remained between 2% and 4%. During an economic bust, property prices could devalue, like they did during the 2008 Recession. However, in the current real estate market, investors could get a high profit from appreciation.
Over the past year, real estate appreciation has increased a whopping 14.5%.
Although many real estate investors consider the average home value appreciation as a valid indicator for future value, you should also keep in mind that housing prices can change in unpredictable ways. Just consider the pre-pandemic 2019 year when house appreciation rate was just 4% compared to 2021’s 14.5%.
To get the best of both worlds, you can combine real estate appreciation with cash flow from rent. Rents typically grow every year, which can lead to increase positive cash flow. So even an initially negative cash flow has the potential of turning positive over time and also allow you to make a decent profit via appreciation.
Why You Should Opt for Cash Flow
Appreciation is a more conservative way to make money in real estate. It allows you to build wealth for your future and comes with a bigger payout than cash flow investing, providing you with income in small installments over time.
One big advantage of appreciation is that you can actually pass your real estate wealth to future generations, allowing them to reap the benefits as well.
As a real estate investor, you can also take advantage of real estate appreciation by fixing and flipping your properties. You can buy an apartment, a house, or a multifamily property, fix it and upgrade it to increase its value, and then sell it. You can also buy and hold the property, make cash flow from it in the meantime, and then sell it.
So Should You Invest for Appreciation or Cash Flow?
If you are looking for a side hustle in real estate, you will benefit the most by having some extra cash to fund your current lifestyle and security for the future. The best thing about real estate investing is that you can do both!
If you have enough know-how, you can make both cash flow and appreciation from a single investment. If you have enough money to buy multiple properties, you should diversify your investments and put some eggs in the cash flow basket and others in the appreciation basket.
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