Two widespread real estate investment strategies are cash flow and the appreciation of a property. Both strategies have the potential to earn a profit and a return on your investment, but they each have their downsides as well.

This article will define cash flow and appreciation, explain the pros and cons of both, and highlight the factors to consider before investing. 

After reading this article, you will be more confident that you’re choosing the right investment strategy for your financial goals.

Key Takeaways

• Cash flow investments can be suitable passive-income streams if they have positive cash flow. If the owner can rent the property and earn more rental income than the sum of the property’s expenses, they can enjoy consistent cash every month.

  
  

• Appreciation investments are a long-term strategy for property owners to accumulate wealth as the value of their property increases over time. Appreciation strategies are great for those looking to pass down their wealth through generations or avoid taxes on their increased wealth.

  
  

• Considering the property, market, and your financial goals is crucial when deciding which strategy to implement for your investments. It is possible to utilize both strategies, but it may be costly and challenging.

What is Cash Flow in Real Estate?

Cash flow is the term used to describe the leftover rental income you have after subtracting all expenses paid on the property. 

A positive cash flow means that you receive more money in rent than the costs of the property. A negative cash flow means the expenses exceed the total rent received. 

To encourage positive cash flow, you must only invest in a property where the rent will cover all expenses and provide some additional cash to be taken as profit. 

To ensure you receive this positive cash flow, you have to face the tradeoff of losing the property's appreciation value. 

This is because properties that have low enough costs to ensure you a positive cash flow won’t be in a market with high appreciation. Your property will still earn appreciation, but simply not as quickly. 

How To Calculate Cash Flow

To calculate cash flow, you can follow these simple steps:

• Calculate your gross rental income

• Subtract operating expenses

• Subtract fixed expenses such as mortgage, interest, and tax

This final number will give you an idea of how much you can make from a property; however, it is essential to remember that all of those variables can change and affect your cash flow. 

Your rental income will vary depending on how much rent you charge and if you have any vacancies. 

Your operating expenses are variable and can increase drastically if you incur unexpected costs, like broken walls, leaks, broken AC, etc. 

Your mortgage payments could also change if you have an adjustable-rate mortgage.

To help keep track of these expenses and ensure your information is up to date when calculating your cash flow, you can use software like Trustworthy. 

Trustworthy is a cloud-based software that can organize real estate documents into a simple online system. It also allows you to share these documents with real estate experts or other collaborators securely.

What is Appreciation in Real Estate?

Appreciation in real estate describes the increase in your property’s value over time. When you first buy a property, the initial value minus any remaining mortgage balance is your equity. 

As the property's value increases over time and you make payments on the mortgage, the difference between the value and mortgage balance grows, and so does your equity.

With this continued increase in equity, the appreciation of the property allows you to increase your wealth. 

You must sell or refinance your property later to receive the return on your investment from an appreciation strategy. For this reason, appreciation is a more long-term strategy than cash flow and is not as consistent. 

It is not always guaranteed that your property will appreciate, and it may take several years to see a significant increase in value. With this in mind, some people buy properties at lower values so they can renovate or fix them up to increase their value manually.  

It is also difficult to calculate how much your property value will increase over time as several factors determine it. An excellent way to get a general idea of the value of your property is to compare it with similar properties in the area or hire an actuary. 

Pros of Cashflow in Real Estate

Now that you have an overview of both strategies let’s go into more detail about the pros and cons of each. 

Here are some of the main reasons why investors typically use cash flow strategies:

Steady Passive Income 

Owning a property with positive cash flow will always give you extra cash at the end of the month. You can ensure you cover all property expenses while still receiving a profit that you can put toward other costs. 

It is also recommended to have as many properties with positive cash flow as possible. The more properties you have bringing in a profit at the end of each month, the more diversified your investments are. 

More Financial Security

A positive cash flow property will likely not be affected by economic factors. The cash you earn from your property will be consistent and grant you a stable, passive income. Having extra cash on hand is always more reassuring as unexpected expenses can pop up.

Easier To Get Approved For a Loan

When applying for a loan from a bank, one of the things they will check is your income. A property with positive cash flow boosts your income and shows the bank that you are financially stable.

This will increase your chance of receiving a loan from the bank, which you can use to invest in other properties. 

Increased Income While You Pay Off The Mortgage

With the extra cash you receive from your property, you can reinvest some of the income into your mortgage payment. The more equity you have on your property, the more wealth you will generate. 

You can also reinvest the money to improve the property and raise its value. These value increases could allow you to charge more for rent, increasing your cash flow even more. 

Cons of Cashflow in Real Estate

While cash flow investing has a lot of perks, there are also some downsides to consider. 

The downsides of cash flow investment are:

Potential Loss From Incorrect Calculations

A potential risk when using a cash flow investment strategy is that you could miscalculate your expenses. If you expect to spend less money than you end up spending, your property could have a negative cash flow, meaning you lose money. 

Aside from miscalculations, there can also be unforeseen circumstances that affect the property value or changes in the expenses you initially used in your calculations. 

There is always a risk of damage or newfound problems with your property that can cause problems and decrease cash flow. 

It Can Be Difficult To Find a Good Property

To fully enjoy the benefits of a cash flow investment, you must find a property that offers a positive cash flow, but this can be easier said than done. 

Finding a property that offers positive cash flow can take a lot of work, especially in markets with unexpected appreciation rates and a history of iffy tenants. 

To help counteract this, you can expand your search to different markets and focus on areas already known as positive cash flow properties. 

Real Estate Market Can Lower Your Rates

All factors affecting your cash flow, including interest rates, inflation, and taxes, can change and impact your income.

In the real estate market, tenants and renters alike are affected by inflation and changing economic conditions. These factors can affect your vacancy rate or interest on your loans and negatively affect your cash flow. 

Pros of Appreciation in Real Estate

If you’re looking for a long-term investment strategy then you may benefit more from appreciation. Here are some of the significant benefits of an appreciation strategy:

Steady Increase In Value

The main goal of an appreciation strategy is to purchase a property and then sell it after its value has increased. In recent years, the prices of houses have seen ups and downs but generally have steadily increased.

If you want to invest and earn wealth more passively and over the long term, appreciation can help you. 

Pass On Real Estate To Future Generations

Appreciation is a great way to pass on wealth to future generations. The wealth accumulation from your property’s appreciation makes it an excellent asset to pass down through your family. 

They can enjoy the appreciation the property has already gained and continue to enjoy its future appreciation.

This is one of the most common reasons people invest in appreciation. If you already have some wealth, you can invest more heavily in real estate and passively earn more from the appreciation of your properties.

Quick Profit From Fix-and-Flips

The term “fix-and-flips” describes properties you purchase and then intend to sell after renovating and fixing them up. This is a more manual way of letting your property gain value and appreciation, which can be accomplished in a shorter period.

By renovating or fixing up some parts of the property, you increase its value. You can then turn around and sell the property for a profit. 

Potential To Defer Taxes

If you purchase a property, you can enjoy its appreciation without tax. Through 1031 exchanges, you can sell that property later, after it appreciates, and buy another property to invest in without facing taxes for the increased value. 

Cons of Appreciation in Real Estate

Appreciation is a great long-term investment strategy; however, there are some downsides and risks that you must be aware of when considering this strategy. 

These risks include:

Potential Market Crash

One of the major risks of an appreciation strategy is that you are depending on the market price of your property to increase, and the market is very much out of your control. There is always the potential of a market crash that will significantly decrease the value of your property.

This risk especially applies to short-term investments. A market crash can be devastating if you plan to buy and sell a property within months or just a few years. Focusing on long-term appreciation strategies will decrease the risk of a market crash harming your property’s appreciation.

Depreciation

While a property’s value typically appreciates over time, it can also decrease. This is known as depreciation and is caused by several factors, including your property’s condition (design, appliances, available utilities, etc.).

More outdated properties will depreciate if they do not meet market standards, so it may be necessary to renovate and bring the property up to industry standards.

There are also environmental factors that can cause depreciation. For example, the surrounding neighborhood and businesses will affect the value of your property and could cause it to depreciate over time.

Factors To Consider For Real Estate Investing

Before you decide between cash flow and appreciation investment strategies, there are several factors to consider.

Property

The first thing to consider in either strategy is the property itself. Positive cash flow requires a property that will have a higher rental income compared to the cost of maintaining the property. Appreciation requires property in the right area and in good condition to appreciate sufficiently. 

This is where your calculations and research will come in. Do plenty of research on the property to get the most accurate information possible before your purchase. Check rental listings in the surrounding area and similar properties to see what they're listed at. 

To calculate appreciation, you can see what your property and surrounding properties were worth several years ago. You can also look at historical data for appreciation rates in general for that area. 

Use these numbers and research in your calculations to determine what strategy will work best for you. 

Market

The property and its investment value are heavily affected by the market that it is located in. Some markets are better for cash flow strategies, and some are better for appreciation. 

Typically, in the southern and midwestern United States, small towns have excellent markets for cash flow properties. However, more popular and larger cities like San Francisco or New York have properties that appreciate at incredible rates. 

The strategy you choose should align with the market you’re in and the properties available to you.

Investment Goals

The final factor to consider is your investment goals. Consider whether your goal is to have money on hand at a moment's notice or whether you can afford to play the long game.

Appreciation strategies are much more long-term and require patience. Cash flow strategies can be more consistent and will grant you passive income in the short term. 

Consider the pros and cons of both strategies and how they align with your goals before making your final decision. 

Can You Do Both?

You may be wondering if you can get the best of both worlds by focusing on both real estate investment strategies; the answer is yes. You can fund separate rental and appreciation properties or enjoy the benefits of both strategies in one property. 

To be able to invest in separate properties for cash flow and appreciation, you need enough money. The maintenance and upkeep for both properties will add to your overall costs, so it’s important to ensure you have positive cash flow in one property and the other is appreciating. 

To enjoy the benefits of both strategies in one property, you must find the right market. Finding a property that will grant you a positive cash flow in a good area is difficult but possible. You can use some of the rental income to renovate and contribute to its appreciation, then sell it years later for a good profit. 

It is possible to implement both strategies, but it might be costly and difficult to find the right properties. Focusing your efforts on one strategy and saving yourself initial costs might be easier. This will also make narrowing down a market and property that suits your goals easier. 

Frequently Asked Questions (FAQs)

How does appreciation create cash flow?

Appreciation of a property can increase the rent over time. If you already have a positive cash flow, you can enjoy more rental income with an increased rent. Neutral or negative cash flow properties can also appreciate and turn into positive cash flow over time. 

What is a good cash flow ratio in real estate?

There are several opinions about the ideal ratio for a cash flow investment, but the ideal ratio is anywhere between 8-12% return. This ratio will allow you to survive fluctuations in the market while still making a profit, maintaining a positive cash flow. 

What is the cash flow rule in real estate?

The 1% rule in real estate is that if your property rents for at least 1% of its value, it will likely net you a positive cash flow. You can make this calculation before making your investment to give you a general idea of the potential cash flow of a property. 

Does real estate appreciation beat inflation?

Real estate appreciation matches inflation fairly closely. In times of inflation, the appreciation of real estate typically increases. Due to the decrease in new real estate being built, existing real estate increases in value. In times of lower inflation, a property will still appreciate, but at a lower rate.