When it comes to a real estate investment, the goal is to make money and reap a high return on investment (ROI) in the form of cash flow returns and/or accumulated appreciation.
Essentially, these are the two main ways to reap returns in real estate investing: short term rental income vs. long term appreciation. Keep in mind there is no right strategy and both reap returns, but it all depends on the investor’s business goals and objectives. Now, there is more risk incurred in investing for appreciation. Continue reading to find out why.
Related: Return on Investment in Real Estate Investing- Mini Guide
Investing for Cash Flow on a Real Estate Investment
It needs no mentioning that many investors buy a real estate investment to earn cash flow returns or rental income every month. Cash flow is the profits landlords/real estate investors collect from leasing their rental property to tenants. To calculate your cash flow returns, you take gross income (rent) and subtract your total expenses (i.e. mortgage payments, taxes, insurance, repairs, etc.). Reaping a surplus of cash flow every month means your net returns exceed your expenses and cost affiliated with your rental property (carrying and fixed costs). So in a nutshell, your net income is money in your pocket. It doesn’t get better than that folks!
But beware to have proper calculations and real estate analysis in place before you buy the real estate investment. It is crucial you estimate your projected net cash flow returns/net profits by weighing your cost/profit analysis. To help you do this, check out Mashvisor’s rental property calculator to give you accurate estimates on your rental property’s overall ROI and net returns. Mashvisor’s rental property calculator is customizable, allowing investor and real estate agents to punch in their own numbers to get the correct returns.
Do not neglect price-to-rent ratios to capitalize on a real estate investment with positive cash flow returns. The price-to-rent ratio is one metric that can give you a straightforward answer on whether or not you will reap cash profits from the rental property in question. For example, Atlanta has better price-to-rent ratio than say, Los Angeles. So if you are investing in real estate solely for cash flow, Atlanta is your better bet.
Related: All You Need to Know About Price to Rent Ratio as a Real Estate Investor
Investing for Appreciation on a Real Estate Investment
On the other hand, investing for appreciation is a lot different from investing for cash flow. Unlike cash returns, appreciation is accumulated over a period of time and your ROI is realized over a much longer term than investing for a surplus of rental income every month. With this said, investors who focus on appreciation take on a much riskier real estate investment because their returns come back years down the line and they may not incur the positive cash flow returns needed to cover the rental property carrying and holding costs.
If you are solely focused on accumulating long term real estate appreciation, you will most likely pay your monthly costs out of your own pocket and not your tenants because your rental income may not be high enough to cover your total expenses. As a rule of thumb, if investors choose to invest for appreciation, they will invest in areas with bad price-to-rent ratio. This is how the formula looks if you invest for long term financial rewards instead of quick cash flow returns:
Higher purchase price + lower rent collected = bad price-to-rent ratio
Los Angeles, California, for example, is the best area for real estate appreciation and many real estate investors made a fortune for capitalizing on real estate investments in this State, especially in Southern California.
Related: California Housing Market 2018 Forecast- What’s the Deal?
So is it worth it to invest solely for appreciation?
YES, it is! Let’s take a look at California. It has been widely known that California is amongst the most popular States for real estate appreciation. It experiences drastic increases in real estate prices and a lot of investors jumped on real estate opportunities in this area without thinking twice. These real estate investors are completely fine with losing money every month because they predict their returns will come later once their real estate investment appreciates in value and they collect a big sum on that appreciation.
But keep in mind, appreciation poses a very high risk in real estate investing. The higher the returns on investment, the higher risk incurred by the real estate investor. Appreciation is never guaranteed.
Investing for Cash Flow vs. Appreciation in Real Estate
We cannot tell you which real estate strategy to choose because both are sound investments and reap ROI. However, for the risk-averse investors out there, play it safe and invest for cash flow returns. For expert real estate investors, don’t discount real estate appreciation, respective to the right location of course.
All in all, what matters is how you go about searching and conducting your real estate analysis. Choosing the right location is detrimental to deciding which real estate strategy to capitalize on. Not all cities are fit for both cash flow and appreciation and depending on where you want to invest, it makes it easier to choose between the two.
Last key takeaway: investing for cash flow is less risky than investing solely for appreciation.
Conclusion
To make money in real estate investing depends on your business goals. You must figure out what you want before you start honing down on the right real estate strategy. Successful real estate investors think outside the box and are very thorough in their research and adapt to current market conditions to make the best real estate investment, respective to macro and micro real estate conditions. Investing for cash gives you quicker returns, whereas investing for appreciation is higher risk but reaps you higher returns if done right.
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