Real estate investors make mistakes all the time, but one mistake in particular – which has doomed countless investors – keeps getting made again and again. The mistake we’re referring to is investing based upon future appreciation as the main or only income source. In this instance, if the property doesn’t appreciate in value, you lose. We hear all sorts of reasons for why investors buy these properties, but at the end of the day we simply ask investors this question: Why do you want to buy a property that is losing you money every month, when there are all these properties over here that will put a bunch of money in your pocket every month?
Past Performance Does Not Guarantee Future Results
Does that line sound familiar? It should, you’ll find it on just about every investment prospectus. The funny thing is, people never seem to pay much attention to that statement. Just because some fund went up 50% last year, doesn’t mean it is going to do it again this year – the same principal is true for real estate markets. In fact, when real estate prices increase so dramatically over a short period of time, you can typically expect a correction to follow. Do you remember that little housing bubble issue we had not so long ago? Prices went up sharply over a short period of time – becoming unsustainable, and naturally forcing the market to correct itself.
Sure, it is possible to hit a homerun and buy a piece of property at the perfect point in time – watching it appreciate 30% or more over a short period of time. For every investor that hits that homerun, though, don’t forget about the nine others that strike out. Let’s continue with the baseball analogy a little further.
You are a baseball player up to bat. The game is tied in the bottom of the 9th. There are two outs, and a runner on 2nd base representing the winning run. The defense has pulled their 3rd baseman in favor of an extra outfielder. If you simply pull the ball down the 3rd base line the run will score, and your team wins the game. Do you take the single and win the game, or do you take your chances and try to hit a homerun?
Yes, this is meant to be a silly question. Of course you would take the single – right? Why take the risk of trying to hit a homerun, when you can achieve the same end result (winning the game) by doing something so much easier?
If you think about it, though, this scenario applies to real estate investing as well. Cash flow investing is the easy single, and investing for appreciation is the homerun. They both achieve the same end result if successfully executed, but one of them is much safer.
The Power Of Knowing Your Profit Before You Buy
The simple reason that cash flow investing is so much safer than investing for appreciation, is that you know your profit before you ever buy the property. If you buy a cash flow property – especially one with a tenant already in place – you know exactly what the monthly income is. Calculating monthly expenses can be a little more tricky, but really it isn’t all that hard – you can download numerous checklists online that will get you within 90%+ accuracy on expenses. So give or take a few bucks, before you buy a cash flow property, you know what the net profit is going to be.
Conversely, with appreciation based investing, you really have no clue. Sure, you can make assumptions about future growth, and so on, but at the end of the day that is all conjecture. Even if you know about some big project that is in the works, which will completely revitalize an area – those plans change all the time. There are no guarantees when it comes to appreciation based investing.
Another important point to make here is that just because you are investing in a cash flow property, it doesn’t mean that you won’t also enjoy property appreciation. Cash flowing properties appreciate, just like non-cash flowing properties. The only difference is that cash flowing properties put money in your pocket every month – regardless of whether or not the property increases in value. If the market tanks – so what? If the market goes up 30%, great – you get to enjoy the best of both worlds.
Real estate investing isn’t rocket science. In reality, it should be pretty easy. Some investors try to make it more difficult than it needs to be by trying to hit that homerun every time, but why swing for the fences when a simple single will do the job?
Cash flow investing isn’t necessarily a slam dunk, but it is much easier and safer than appreciation based investing. You still need to do your due diligence, buy in the right areas and have competent property management in place. There is a story that numbers don’t always tell – make sure to assess the risk behind the numbers – like ensuring your tenants have the means to continue paying rent, and so on. If you are new to the business, or don’t have the time or desire to deal with this kind of thing, there are companies like ours who can do it for you. We provide turn-key, cash-flowing properties to investors, with tenants and full property management already in place. It doesn’t get much easier than that.
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