Are You an Income, Growth or Value Investor - and Why it Matters!

If you ask anyone who makes their living trading stocks whether they invest in growth, value, or income, you will likely be given a long-winded answer / treatise on the subject.  Day traders all seem to have their own preferences and investing philosophies when it comes to their basic strategy. 

Asking a real estate investor the same question, on the other hand, is likely to just produce a blank stare.  For the most part, we do not frame our strategies in these terms.

That is a mistake.  Real estate investors would benefit from using a bit of analogous thinking; comparing their rental portfolio to a stock portfolio.

Income Properties

There are really two separate profit mechanisms for buy-and-hold investors: property appreciation and cash flow.  If you're one of the many real estate investors who value cash flow above all other factors, you would fall squarely into the Income Investors camp.

More often than not, the properties which produce the best cash flow are not likely to perform as well from an appreciation perspective.  In most markets, the highest cash flow can usually be achieved by investing in low Class B to C properties. 2-4plex and apartment properties also usually offer good cash flow but generally slower appreciation.

In our stock portfolio analogy, these properties are offering strong dividend yield, but relatively limited capital gains.

Growth Properties

Growth stocks are those hot companies whose market and valuation is still expanding.  Growth companies might offer limited dividends, but most of their returns are achieved by increasing the value of the company - and thereby the value of your shares.

In real estate, these will generally be Class A properties in the highly sought-after areas of town.  Investors will not generally be able to buy such properties for below market, which means their cash flow potential is limited.  However, the total return can still be quite attractive since these properties can usually be expected to increase in value nicely.  In my observations, many of the folks here on BP chase cash flow.  This isn't a bad way to go - there isn't just one right way to invest in real estate.  But if all you look at is cash flow, you may not be seeing the larger picture.  (Want proof?  Just take a look at where most of the 'big money' currently invests in real estate... high end condos and commercial properties!)

Remember - if your goal is a 10% return, but your property is gaining in value at 5% per year, your required cash flow needn't be great to achieve your objective.

Value Properties

The last class of investors are those whose primary goal is to find properties which can be bought for less than 'retail'.  Flippers and wholesalers would fall into this category, but so would buy-and-hold investors who value purchase price discount above cap rate.

Why does it Matter?

You need to have a firm understanding of what your investing strategy is in order to optimize your total return.

When holding a growth property, you should be keenly aware of market swings and trends, and be ready to lock in your gains by selling once you perceive market valuation trends are beginning to move against you.  This is especially true in the markets which are more volatile (CA, FL, NY, Vegas, etc), which also happens to be where you find the greatest number of growth investors.  A drop in housing prices can mean negative returns for the growth investor.

For an income investor on the other hand, you can easily weather market dips and swings in price, but need to closely watch vacancy rates and FMR values.  Debt service also needs to be considered if the investor uses leverage;  rising variable rate loans can quickly eat into cash flow.  Finally, income investors need to be cognizant of how the age of their properties affects repair and capital expenses.

The Bottom Line

There are multiple paths real estate investors can take to generate good returns.  Whatever route you choose, make sure you have a firm road map in mind so you can evaluate performance along the way and aid in strategic decision making.