“Real estate is a great investment” is often said to people looking for somewhere to invest their money. While it’s true that real estate is a good place to invest, oftentimes better than the stock market, it’s only part of the equation. Investing in real estate is one thing; investing in real estate wisely is an entirely different thing altogether. Wise investing takes planning, which includes:
- Identifying the right markets to invest in
- Knowing which type of real estate you want (i.e., single family, multifamily, commercial, other)
- Setting your investment goals
Regarding goal setting, there are a couple of options: invest for cash flow or appreciation. Investors can choose to go for one or both, but there are compromises with each strategy. Let’s take a look at the benefits of each one to understand why.
How do I decide between investing for cash flow or appreciation?
Before deciding if cash flow or appreciation works best for your investment strategy, let’s define each one and identify some of the pros and cons:
What is Cash Flow?
Cash flow is defined as “the total amount of money being transferred into and out of a business, especially as affecting liquidity.” In the case of real estate investing, cash flow is the money collected from a rental property or properties every month after expenses. Cash flow works like this:
Your property management company collects monthly rent from your tenant(s). Expenses like maintenance, property management fees, HOA fees, insurance, and property taxes are then deducted from the rent. (Some of these expenses are only deducted annually.) After expenses, the money left over represents cash flow (also known as net income).
What is Appreciation?
Appreciation is defined as “gratitude for something,” like the feeling you have when someone buys you a birthday present. Appreciation is also defined as “an increase in monetary value.” In real estate, appreciation occurs when a property increases in value over a given period of time. Real estate can appreciate in value for numerous reasons, like when mortgage interest rates go down, the demand for real estate increases, or there is a lack of real estate supply.
Is it better to invest for cash flow or appreciation?
When choosing to invest for cash flow, it’s extremely important to know where to invest. Cash flowing properties should have a favorable rental rate as compared to the property investment cost. Many investors use the ‘one percent rule’ to determine whether a real estate investment will provide enough cash flow. The ‘one percent rule’ states that the monthly rent of a property should be equal to (or greater than) one percent of the investment cost. So for example, a $150,000 investment property should rent for at least $1,500 per month. The ‘one percent rule’ is not always possible to achieve, depending on where you invest. It’s also a hotly debated topic among many real estate investors as to whether it’s worth using as a measurement. Deciding how much cash flow is enough should be determined by each investor based on their personal goals.
Investing for appreciation is great for the long-term, portfolio-minded investor. When monthly rent checks aren’t the main goal, it opens up a wider variety of markets and investment opportunities. Rather than looking for properties with favorable investment-to-rent ratios, focus on markets with strong economic growth, growing population, and other favorable situations for investors. Areas like Dallas and Fort Worth are great examples of markets with strong appreciation in single family home values.
Is cash flow or appreciation better for you?
It’s a personal dilemma. The question is not about whether cash flow or appreciation is better. Which one is better for you? The decision ultimately depends on which strategy will help you achieve your investment goals. If you are investing to generate monthly income, cash flow is probably your best strategy. If your goals are focused on the long-term, aimed at generating larger returns in the future, choose properties that have a higher likelihood of future appreciation. Whatever you choose, American Real Estate Investments can help you identify the best property for your portfolio. Contact us today to discuss our turnkey investing opportunities.
This article is for informational purposes only. For information specific to your investment situation, consult with a qualified tax adviser, CPA, financial planner or investment manager.