Whether you’re new to investing or you’re a seasoned real estate investor, there are really two ways to build a real estate portfolio that helps you attain financial freedom or stability. One is by investing for cash flow and the other is through appreciation (or the asset’s potential increase in value). While some investors may prefer one of these strategies, others try to incorporate both.
For many years, I thought buying properties that cash flowed was the only way to go, especially since that extra cash helped to cover the cost of repairs and rising taxes.
More recently, covering the cost of rental licenses and inspections has become a consideration as well.
Some towns where I’ve been investing in for the last 30 years not only charge inspection fees but also re-inspection fees, and now they want everyone to be licensed and to carry permits. It’s gotten so bad that our property management company is starting to charge for inspections due to how time-consuming and burdensome they are.
As for me and my long time real estate investor buddies, sometimes we discuss the recent chain of events over the last few years, and the idea of investing in cash flowing properties as a buy-and-hold strategy no longer seems as appealing as it once was back in 1989 when I first started.
Back then, if you had a problem tenant, you could actually call the township and they would help you get them out. Today, things have really changed. Not too long ago, I called the township to report an abandoned car in the alley behind my property, and the next thing you know, the township was fining me for the abandoned car.
But as my investor buddies (with 100+ properties each) have pointed out lately, if it wasn’t for their flips, they wouldn’t be making much money. When using the buy-and-hold strategy, with its increasing property taxes, wear and tear, and constant turnover, they’re lucky if they break even. Keep in mind, these were places that usually always cash flowed at least $300 a month and were blue-collar, 2 and 3-bedroom homes that were under $100,000 outside of Philadelphia.
So, What’s an Investor to Do?
Most of you know my story, that I was on the path to own 100 properties too, but I stopped at 40 places and moved more into the note and private money space. Today, I still have 19 buy-and-hold properties, and it’s getting tougher and tougher to deal with all of the challenges. Some of the areas that were once cash flowing great aren’t in the greatest neighborhoods or have the best clientele anymore, and to be quite honest, they really haven’t appreciated all that well.
In the last uptick, I was fortunate to be able to consolidate some, but now my strategy is a mix between further consolidation and paying down on the debt in order to cash flow more as I approach retirement. As all of this is happening, I’m starting to realize that cash flow isn’t always everything. If the area changes, the properties become more obsolete and the cash flow may not be what it once was.
Investing for Appreciation
Today, as a higher income earner, cash flow isn’t my only consideration. I’m willing to consider less yield, as I don’t really need more income. I also like nicer properties in better areas with some chance of appreciation, even if they don’t cash flow quite as much. If I can get newer places with better schools, I can attract better tenants, and with more demand, I can keep raising rents. I may also see more significant appreciation in the surrounding counties with more jobs and economic growth.
Today, I invest more for capital gains than for just income. As I mentioned, though, this wasn’t always the case.
If you’re not a high income earner and you’re just starting out in investing, it’s probably more prudent to invest in real estate for cash flow (to add income streams and to protect yourself from the asset’s possible loss in value). Of course, this decision should really be guided by your investing goals.
The ultimate goal, in my mind, would be to incorporate both into your real estate portfolio. That way, your cash flowing assets can offset the properties that don’t bring in that much cash flow.
If you are investing in a property for the potential appreciation, another way to increase your cash flow on the deal may be to tap into the available equity.
Tapping the Equity
The one strategy I’ve employed lately in the nicer properties I have that have appreciated is to tap into the equity with a home equity line of credit (or HELOC) with a low rate, and then either lend the money out to rehabbers with 13-18% returns or to invest the money in performing notes. The spread I’ve created through this arbitrage model has more than offset the lower cash flow I once had and has made these properties the gems in my portfolio.
So, which strategies are you using to add gems to your portfolio — investing for cash flow, appreciation, or both?
Let’s talk in the comments section below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.