Understanding Real Estate Cashflow and Why It’s Important
To cash flow or to appreciate? This is the million-dollar question of rental property investing. And one that has been examined, debated, and studied six ways to Sunday. These two different schools of thought on how to make money on rental properties have often been argued as a matter of preference. At ADPI, however, we’ve got our own reasons why one is better than the other, and we’re here to tell you about them.
First, though, here’s a quick introduction to each of these money-making options:
Cash Flow
If you’re getting into the rental property market, you’re in it to make money, right?! Well, let’s hope so.
One of the most popular ways to do that is by collecting monthly rent from tenants that exceeds the property’s monthly expenses. This leftover profit is called cash flow. Though cash flow on a single property average a couple hundred per month, most investors have more than one rental property they’re cashing in on. If you’re making $200 each month on 10 properties, that’s $24,000 of net income through cash flow per year! This profit took some time to accumulate, but it came with minimal risk.
Appreciation
Another way to bring in money via a rental property is through appreciation of that property. This is when a property sees an increase in value, and it can come with high profits if the value increases rapidly. For example, if the real estate market in a certain area is booming, property values could in theory increase from $200,000 one year to $300,000 the next. Sounds awesome, right?! Well, this approach to real estate investing is also extremely risky.
No property is guaranteed to increase in value quickly, or at all, and as everyone saw in the recession of 2008 properties can decrease in value significantly in difficult times. When this happens, investors continue to lose money each month on these stagnant properties. At best you can find a renter to pay the mortgage amount and break even, at worst, you lose money every month, even with a renter in place.
So, which one is better?
Honestly, we think cash flow is the best option when it comes to rental property investing. Even though appreciation can set you up for financial success in one go — if it’s a big one — it can’t be accurately predicted. Its potential is high rewards, but it can also come with high losses. By choosing the cash flow method, however, you’re able to guarantee money each month. Appreciation is a gamble on the potential of the future – Cash Flow is guaranteed monthly income, with the additional opportunity for appreciation as well.
As you contemplate the best course of action for your rental property game, here are some things to think about:
What is your financial freedom number?
Here at ADPI, we talk a lot about your financial freedom number. This is the amount of money it would take for you to reach your financial goals — getting out of debt, early retirement, having a diverse investment portfolio, living the yacht life. Whatever goals you have for your life, how much money is it going to take to get you there? From a real estate standpoint, the formula to determining this number is pretty simple: what are your expenses and how many properties will it take for you to not only cover them, but profit and reach your goals.
In our No. 1 bestselling book Military House Hacking, we talk more extensively on this topic, even including a forward by real estate powerhouse Rod Khleif, whose “The Lifetime Cash Flow Through Real Estate Investing Podcast” has been downloaded more than 3 million times.
Is investing for appreciation like investing in the stock market?
Yes, yes it is. The stock market’s motto: high rewards come with high risk. Sound familiar? If not, scroll up to “Appreciation” for a quick review. With the stock market, a down cycle means profits are lost, and with an upcycle, profits are increased — sometimes dramatically. Though the risk is worth it to many stock investors, even the best in the business have a hard time predicting which way the market will turn. This is exactly the same concept of appreciation. With cash flow, however, rental properties are going to keep netting each month despite any negative market dips.
How finding good cash flowing investments can help you overcome market corrections
Market corrections mean loss of money, and it’s a hard thing to avoid if you’re serious about your investing game. Weathering these corrections depends on your ability to find good cash-flowing investment options. When it comes to rental properties, it’s not that hard to come by, but it will certainly take some research to make sure you’re investing wisely. MashVisor has a great article that discusses the best strategies for finding cash flow investments. A few highlights include:
- Perform a real estate market analysis to select the right city
- Consider multi-family homes
- Enter into a real estate partnership
- Take advantage of rental property tax deductions
In the words of Grant Cardone, “Cash Flow Is King.” Coming from this multi-million dollar investor, I’d say that’s a pretty telling statement on which way to lean in the cash flow vs. appreciation debate. You already knew that real estate investing was the best way to grow your wealth and generate passive income, and now you know the best way to do that is through cash flow. But how can you take the complexity of compounding cash flow to buy more rental properties? Lucky for you, we’ve created a cash flow calculator app to do the hard math and show you how your wealth and income can grow through cash flow.
