Which Investment Is Best For Me: Appreciation or Cash Flow Homes?
If you’ve been thinking of buying real estate, you might have noticed that the conversation is often about ‘investing for the future’ or ‘building wealth’ typically this notion means, purchasing an investment home, and holding on to it for its’ appreciation (home value increasing over time), while another concept typically talked about is ‘cash flow’.
Both cash flow and appreciation are strong investment strategies, and each has its own set of benefits and drawbacks. It is important to understand how these concepts show up and how they can play a part in your growing real estate portfolio.
In this article, we explain the differences between cash flow and appreciation-focused investments and help you understand which is the best strategy for you.
What’s the difference?
The biggest difference between investing for appreciation and cash flow is the ability to leverage capital to increase the potential return on your investment.
Appreciation
In simple words, appreciation in real estate is defined as the increase in a home's value over time. If a house is bought for $200,000 becomes worth $250,000 after a couple of years, the appreciation on it would be $50,000 or 25%. The appreciation of a home typically depends on:
The surrounding neighborhood
Rent increases in an area
Population increases in an area with limited new units
New laws that prevent specific sites from being redeveloped or existing structures from being demolished
These factors are linked to supply and demand. For example, when more people want to live in an area, demand increases, boosting housing prices. Similarly, demand is likely to increase when supply is limited or made more desirable (e.g., through renovations).
Cash Flow
Cash flow is the excess money after paying off all expenses of your investment home. Cash flow investment is a passive income, wherein revenues cover all expenses - mortgage, insurance, property management, etc. The revenue typically provides leftover money at the end of each month, which is your profit.
Cash flow opportunities are usually found in markets with sustainable growth, where there is a balanced demand for real estate, such as in the Midwestern and Southern regions of the US.
To determine if a rental home is a good investment, you can calculate the cash flow in two simple steps.
Figure out the gross income from the rental home
Subtract all expenses relating to the home
Using these steps should help you calculate the expected cash flow for your home and determine whether it will provide a positive or negative cash flow.
What type of investment is better?
It depends on your goals. Here are a few positives and negatives for each:
Reasons to opt for appreciation:
Real estate values tend to increase over time. So if you make smart investments, it is safe to assume you can sell a home for a profit later.
With levered appreciation, you can avoid paying for the house out of pocket and still enjoy healthy appreciation gains.
Over time, as the income from your property pays down the principal on your loan used for leveraging, you start to build more equity (paid for by your tenants).
Leveraging your investment leads to significant tax deductions because you can depreciate the total cost of the property, not just the amount you invested. You can write off the interest paid on the loan.
If you're making less than $400,000 in annual income, you may be able to defer taxes on your rental homes through 1031 exchanges. Speak with a qualified tax advisor for your specific situation.
Many people who have achieved their financial goals or independence choose to invest in real estate for appreciation as it is a great way to pass on wealth to future generations.
Over time, your cash flow will grow as rents increase etc.
Reasons to opt for cash flow homes:
If you have positive cash flow, your revenue (typically in the form of rent) covers your expenses and gives you additional cash in your pocket.
Cash flow offers steady and consistent cash, that you can utilize to build a reserve for the home, or roll into another investment.
You can still benefit from appreciation, and your cash flow will grow over the long run thanks to rental increases and as you pay down your mortgage and debt.
Conclusion
The debate of whether to invest for appreciation or cash flow is a common question investors find themselves asking. We’ve found that many people are willing to sacrifice cash flow, in lieu of appreciating markets. Focusing on a cash flow strategy is often ideal if you're hoping for a bit of added income per month, whereas, if you're someone who is hoping to build multi-generational wealth, appreciation may want to highly consider.
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