When it comes to real estate investing, one of the most frequently asked questions is whether it’s better to invest for cash flow or for appreciation. As an investor, it’s important to know that both strategies are valid and can even be combined when you’re evaluating an opportunity. You also need to be able to determine how each option is calculated and what those numbers actually mean.

Cash Flow

A cash flow strategy can give you a consistent source of income, which is usually in the form of rent. But over time, the property may also benefit from appreciation. With equity accumulation, you could refinance or sell the property. You might even be able to use your cash flow returns and appreciation to invest in new properties.

The problem is that it’s not always that simple. In many cases, you either have to choose one strategy or the other. You could get a strong cash flow if you buy properties in a low-cost neighborhood, and you could improve upon it with some hard work. With more developed areas, it could be harder to find cash flow investments. So, you may have to rely on appreciation.

Here are some reasons why you might want to implement a cash flow strategy:

• If you have positive cash flow, your rental income will cover your expenses, mortgage payments, monthly maintenance fees, insurance, and property taxes (all while giving you some extra cash).
• Standard loans are available for cash flow investors, because this strategy isn’t only used by investors to evaluate deals. Lenders use it as well. They use the Debt Service Coverage Ratio (DSCR) formula to decide whether a property will be able to generate a positive cash flow after you pay the mortgage payment. And to calculate this ratio, you need to know your Net Operating Income (NOI).
• Investors who want financial freedom, passive income, and an early retirement will use a cash flow strategy, because it can help them to reach their financial goals faster.
• Cash flow from rental properties will give you more versatility. Instead of using a conventional long-term rental strategy, you can list it on short-term rental websites (such as Airbnb). You can also make monthly income by using other systems (such as house hacking). On a larger scale, you could build a portfolio that includes both multi-family and single-family homes to earn a steady rental income.
• Your cash flow will grow over time as you pay down your mortgage and build equity.

Despite all the benefits of a cash flow investment strategy, it does have some drawbacks. It can be hard to find properties that will generate a positive cash flow, especially in today’s market where prices have appreciated at unexpected rates. You’re more likely to find properties that are cash-flow neutral (can only cover operating costs) or cash-flow negative (where the investor spends more money out of pocket on property maintenance).

The success of cash flow investing will depend on market performance and on the quality of your tenants. If there’s a real estate downturn, your cash flow will be affected. And bad tenants will always cause you to lose money.

Appreciation

While there are straightforward approaches and formulas for evaluating real estate cash flow, measuring its appreciation can be more of a challenge. This is probably the reason why many investors choose to go with a cash flow strategy. The best way to determine the market value of a property is to look at comparable properties (referred to as “comps”) in the area.

On average, real estate appreciation rates in the United States have been within 2% and 4%. During a market crash or economic downturn, property values could depreciate in the same way as they did during the recession of 2008. But if there’s a real estate bubble, investors can generate a great deal of profit just from appreciation.

You can also combine an appreciation strategy with a rental cash flow strategy. Rents will usually grow over time, which can result in stronger cash flow. So, a property that’s generating a negative cash flow initially could become positive over time and might even give you an opportunity to benefit from appreciation. The way to make money from appreciation is to sell the property. So, with this kind of strategy, you’re playing the long game.

Here are some of the reasons why people pursue an appreciation strategy:

• Appreciation is a time-tested way to make money as a real estate investor. Property values will usually increase over time. So, if you make sound investments and are patient, you can sell them for a profit.
• Appreciation is a great way to pass on real estate wealth to the younger generation. That’s why a lot of people who have achieved financial independence invest in real estate just for the purpose of appreciation.
• As a new investor, you can make fast profits with “fix and flips.” You buy a property and fix it up in a way that will increase its value. Then, you can sell it to make some quick money. You can also buy and hold, make positive cash flow in the meantime through rental income, and sell it at the right time.
• You can defer taxes on real estate sales through 1031 exchanges. This is a fantastic tax strategy many investors utilize to build significant long-term wealth.  There are a multitude of rules associated with the 1031 exchange strategy, however, so make sure you due the appropriate due diligence here and include your CPA in this type of transaction.

When you’re relying on appreciation, you’re making a gamble on the real estate market. You will need to look at city plans, study municipal data, and invest in areas that are close to transportation facilities. In other words, you need to look for areas where large groups of people are moving. And there’s a chance you could still lose because no one knows the future and there are numerous things outside of your control.

Final Thoughts

With regard to both strategies, there isn’t a winner or a loser. Both strategies can complement each other, especially in situations where it’s hard to predict the future. Here at Shakiba Capital we are primarily focused on cash flowing real estate which has the potential to appreciate long-term.  This has served us extremely well in all types of market as cash flow is king!

If you want to know more about how you can make money investing in real estate, be sure to get in touch with Trevor Shakiba at Shakiba Capital.