This article is an excerpt from our no cost Ultimate Guide To Passive Investing. You can download the full guide here.
Invest for Cash Flow or Appreciation
Understanding what you’re looking for in an investment is critical as a passive investor. There are great opportunities in every niche, however it’s important that you align your goals with the best investment to get you there.
When I started out my investing journey I began by investing for cash flow, I just didn’t know it. My goal was to create enough income from renting my home on Airbnb that I could fund my startup while covering personal expenses. Each month I would rent my home for one to two weeks to generate some extra cash flow.
Later when I began investing full time as a house flipper, I began investing for appreciation. My new goal was to earn as much money as I could. I would buy a property for a low price, make some renovations to force appreciation, and then sell for a profit. Both are great strategies, but where I failed was not being clear on my ultimate goal – why I was investing in the first place. I thought that by earning a lot through appreciation, that I would also see income I could count on. Each strategy has its pros, but the important part is getting clear on the outcome you’re after.
Thankfully I finally got clear early in my career. I was able to switch my focus to getting consistent returns from assets by investing the money I made working full time. Now I get the best of both worlds.
Let’s look at a simple example:
Investing for Cash flow
John is a full time executive with a big family. He loves what he does, however he’d like to create a consistent flow of income so he can reduce his hours to spend more time with family. He’s looking for an investment whose returns will help offset his income to eventually quit his job.
His goal is to generate $4,000 per month in cashflow. If he’s able to do that through passive income, he’ll switch from a full-time to a part-time role, giving him more time to spend with his family.
When reviewing passive investing opportunities, he sees that she can make about eight to ten percent in cashflow per year in any of the multifamily real estate syndications he’s found.
In order to get $4,000 per month, or $48,000 per year, in cash flow, John would need to invest roughly $600,000.
$600,000 x 8% = $60,000
With this guideline in mind, he can focus his investments on investment opportunities with projected cashflow at eight percent or higher. He knows that if he can move some of his retirement investments into real estate, this will help him get closer to this number more quickly.
Investing for Appreciation
Brady isn’t interested in cash flow. He makes a steady income from both active and passive sources.
He doesn’t mind cashflow, however his true goal is to see the biggest returns possible on his money. He doesn’t have a need to live off the money, and is investing for potential appreciation. He has seen how big cities like Austin, Denver, and New York have had huge upswings in real estate values and he wants to make that bet. He knows these come with higher risk, however he’s okay with that.
Brady is okay waiting a bit longer for a bigger payout, rather than getting income each month. And his risk tolerance is higher, so he’s okay taking a shot at higher returns, even if it comes with more risk. He just wants the chance to see that appreciation.
Investing for appreciation often is seen as a riskier investment, and many will tell you to invest only based on cashflow. It’s true that there is often more risk, but for some the rewards are worth the gamble for the chance at a higher payout. Some are having big success here, yet there are also many who have lost money investing for appreciation.
Brady knows the risk, and is happy to take it. He’s looking for investments in appreciating markets, new development opportunities, as well as value-add deals (properties that allow for improvements which increases income that adds value), so he can maximize his chance for appreciation.
The Hybrid: Investing for Cash Flow & Appreciation
Blending the two can often lead to the best of both worlds. Many experienced investors look for opportunities where they can get some cash flow throughout the life of the project, but also look for value-add opportunities that maximize the potential for appreciation.
A Hybrid Model is the sweet spot where we like to invest our capital. Ongoing cashflow helps us see a return on investment each month while benefiting from the upside of a successful deal.
This is why it’s so important to be clear on why you’re investing. You can make decisions on what the investment will deliver, not just the pretty photos or story of the project. Those things matter, but what matters most is you’re hitting your personal investing goals!
That way when the right deal comes by, you’re able to move forward quickly, and with confidence.