In a hot rental market, it can be easy to buy a property that is increasing in value rather than a property that can generate positive cash flow. The temptation to simply flip a property for a lump payment in the future or near future can be too tempting for some. However, this strategy has some pretty nasty downsides. Let's dive into the differences between appreciation investing and cash flow investing.
Two Kinds of Investing
There are investors who invest for appreciation. This strategy is simple: buy a property and hold on to it (even if it costs you money) and wait for prices to increase. This is a huge gamble. If the local or national economy falters, this plan can become a financial boondoggle very quickly. This is especially true for the small investor (and most RHAWA members are small investors!).
Then there's cash flow investing. The price on this property may not be sky rocketing, but it's generating rent each month which means it's generating cash flow. A great cash flow property covers it's expenses with a little bit of profit. This is much less risky because while tenants may come and go, the property is generating money. Property values may increase or decrease, but if you can keep the vacancies to a minimum, the property will be generating some money. Doesn't that sound better than paying to own a property and nervously waiting for the value to increase?
Many people looking only for appreciation, believe that cash flow is a silly way to make money. Why enjoy a trickle of a few hundred dollars each month when you can get a windfall from quick appreciation of value? However, the risk factors are far fewer. The return is small over time, but the security of the investment is not as dependent on economic factors as simply waiting for the property to increase in value. Appreciation investing can lead to a nice profit, but the risk is much higher. It's really a question of whether you are willing to wait for better money over a longer period of time.
Market Predictions Are Like the Weather....
They are often wrong! And while prices might be rising right now, making appreciation investing an attractive option, it will not be that way forever. Recessions happen, large employers leave, and local recessions happen as well. There are too many economic unknowns to know that your risky appreciation investment will pay off. However, if you are invested in a property generating cash flow, then the economy can change or even downturn, and your cash flow has a much better chance of being sustained over the falling property value of an appreciation-invested property.
It's really the difference between going to work everyday to maintain a steady income from your employment or playing the lottery every week hoping for a windfall. Some money over time is usually better than hoping your luck won't run out at the wrong time.
Want to learn more? The Rental Housing Academy offers Buying Cash Flow Properties which is a great class to learn how to evaluate a property for it's cash flow potential and whether investing in a property makes business sense. Look for the next offering in our Calendar.