Investing for Cash Flow vs. Equity—What Investors Need to Know
Being flexible in how we invest enables our portfolios to hedge the unexpected.
In real estate, there’s a unique duality in rental properties versus home sales that brings many investors to a standstill about how they should proceed. The difference between generating fast income versus long-term equity must be considered in order to diversify how we manage our portfolios.
Passive investing is always my focus, for in building wealth, passive income gives you “the best of both worlds.” As a passive investor who wants to exponentially grow their income, try to find cashflow properties for quick gains. Use capital growth, however, for property sells that return three times your initial principal.
Cashflow vs. Equity—The Big Debate
Investors struggle with cashflow and equity because each offers a profit opportunity but with the need to accept a contrasting way of investing. An investor who doesn’t want tenants but seeks cashflow investments, for example, will never adjust their lifestyle appropriately. Those who want to invest into equity but can’t make a big down payment are, likewise, limited in their pursuit.
How Does Cashflow Work?
Cashflow, as it’s defined in the world of finance, is the flow—the entry and exit—of money within a business or investment. What’s unique about cash is that it’s “liquid.” The money you hold in a savings account is considered cash. It’s accessible and can be spent at your heart’s desire. In regards to property ownership, “cashflow” is an investment that pays you on a routine basis. You don’t need to own a property, but you do, however, need tenants.
The flow of cash is only achieved when your revenue exceeds any expenses you have. Cashflow assets are effective if you find profits after covering these costs:
- Maintenance—Rental properties, especially those derived from foreclosures, require initial overhauls in most cases. The immediate return you get, however, should easily cover your costs later on.
- Interests—A mortgage can be your largest expense in homeownership, but cash investments can, in the short-term, cover your initial costs. Cashflow pays your mortgage and the interest that comes with it.
- Property Management—Whether you labor or a property manager does, cashflow investments only make sense when they pay their own maintenance fees.
What Cashflow is Ideal For
Cashflow investments are suitable for everyone yet fit best with:
- Those Retired—Being passive as an investor is about earning an income while doing nothing to generate it, so cashflow assets work well in retirement.
- Mortgage Payments—Investment properties are ideal cashflow assets, for when there are tenants, though you own the property, others pay its mortgage.
- Portfolio Diversity—Nothing is worse for an investor than to have a single asset that they become overly obsessed with. Cashflow is ideal when you need to diversify through multiple income-generating assets.
What Role Does Equity Play?
In simple terms, equity is the value of a house regardless of the money it generates from its renters. How much equity you’re entitled to is based on how much you’ve paid into your mortgage. In this case, you’ll only generate a profit by paying your mortgage in full. Otherwise, you’ll only gain your principal, which is any initial amount you invested. Tracking your equity requires that you subtract any liabilities from your home’s market value.
The work in managing equity is two fold.
One, you treat a property as a type of savings escrow. Whatever you pay into it, for all general purposes, is yours to collect if the property sells. Two, your property market can increase the rate of your return through appreciation. The basic methods for profiting from equity all require you to spend less than a home’s value—in order to:
- Flip a House—Though not always a short-term strategy, buying low and selling high real fast happens in equity investing.
- Construct—New construction increases the value of a piece of land. This occurs because the property gets developed for practical use, so the end result is equity.
- Rehabilitate—Foreclosures are the best rehabilitation projects to consider. These properties can be bought for a third to one fifth of a property’s real value.
What Equity is Ideal For
Equity can be difficult to track at first, but it’s an effective investment option for:
- Beginners—Buying a house with no intent to be an investor still gives you equity. Those who want to lay a foundation for their portfolios have this option.
- Investors Seeking Diversity—Finding “more than one basket to put your eggs in” is smart. Equity can give you a long-term investment that, through diversity, protects your investment portfolio from risk.
- Exponential Growth—Just imagine what it’s like to multiply an investment by two each time that it increases. Exponentially, it would start at $200,000, move to $400,000, to $800,000 and so on. Exponential growth is compounded in a way that makes your profit potential limitless when investing solely in equity.
The Cashflow Scenario
Investors make the most out of cashflow properties when they take out long-term mortgages.
The basic strategy is to ensure that mortgage payments can always be made with or without a tenant. This scenario calls for you to be or hire a property manager. Advertising for and screening new renters is part of the workflow. Any cost that you incur in creating a livable space, additionally, becomes your personal liability.
The Case Behind Equity
Equity, since it’s based on what you’ve paid, is best pursued through short-term mortgages. The primary challenge you might face is in keeping your workable cash free to use. Short-term mortgages are given with a higher monthly rate to pay. Should you encounter financial difficulties or lose your job, those high payments might destroy you.
Which is Better for Passive Investors?
The beauty of being an accredited investor is that you benefit from both cashflow and equity. There’s no need to worry about which, for these options, together, give you profit on demand and future equity to think of should a property sell.
Your net income, as set by your preferred rate as an accredited investor, is paid out monthly or yearly if you choose. This is a type of cashflow asset. However, since accredited investors work with contracts, they’re entitled to any advances gained from remortgaging a property, which is equity.
*Risk Tolerance—The Role It Plays
Every investment you choose must fit with your tolerance for risk. Your diversity from a passive approach hedges your risks, but if you don’t have paid distributions, you need to decide if the risks can be managed on your own. Risk tolerance is the point in which the loss you incur hinders your emotional, professional or financial life.
Having a mix of cash and equity assets is what balances your tolerance for risk. Should one aspect of this strategy fail, the opposing position you hold in it may still perform.
*In a Crisis, Cash Rules
As a precautionary rule, cash holdings can support you during times of uncertainty. Equity is considered an illiquid asset. Equity, like gold, stocks or bonds, can’t be used to buy food at the grocery store. Illiquid assets, being in the form of equity, can only serve you if you convert them into your fiat currency. The “limitation” of illiquid assets, however, doesn’t negate their profitability. It’s simply important that your investment strategy also includes cash holdings.
The Difference That Passive Investing Makes
There’s an amazing world around us, but being occupied with leaking pipes or broken boilers won’t give you the time to enjoy it. A passive investor needs to be just that—someone who reaps rewards without laboring.
The work you do need, however, is a one-off deal. Once you find an ideal professional to work with, expect consistent profits and a diverse approach to generating your capital gains.
A Final Step Toward Wealth Building in Real Estate
Wealth building isn’t just about having money; it’s about meticulously strategizing how that money is used. Wealth is what I work hard to put into your hands. The only way to produce “income on demand,” however, is with income-generating assets. Wealth differs from income and riches in that it comes from a stable source.
That is, it comes from a source that doesn’t deplete itself. Your next step in creating a passive income is in deciding on how you’re going live the rest of your life. Expect my team to be with you and to guide you along the way.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.