Diverse investors invest in real property for different reasons. The most common reasons for investing in real estate are to generate steady income and cash flows. Cash flows and funding to make quick bucks due to the rise in market prices are two of the most common reasons. This article will compare these options and discuss the risks and benefits.
Investing for Capital Gains vs. Investing for Cash Flow
Predictability: Cash flow investing has the advantage that it is more predictable than capital gain. Buyers looking for capital gains have yet to determine what profits they will make. Many of these buyers believe the economy’s macroeconomic fundamentals will continue increasing prices. This is not true for any economy. The real estate industry is just like every other industry that experiences cycles of falling and escalating housing prices. Others believe in the more excellent fool theory. They expect to find another buyer willing to purchase the property at a higher price, hoping to achieve the same feat as they did. Capital gains investing is mostly a buy-and-hold strategy. Cash flow investing, on the other side, has the element of predictability. Capital gain investors have a good idea of what is coming next. They can therefore predict with some certainty the expected amount of profit on both a short-term and long-term basis.
Sustainability: Investing in cash flows is more viable than investing in capital gains. Because a Cash flow-based strategy is grounded in reality, it is so popular. Cash is coming in every month. Money may come in at a higher or lower level than anticipated. In a well-structured deal, the Cash is sufficient to cover at least the operating costs. The property can operate independently without financial support, making it autonomous. Investors have more control over managing these properties, even if the market is bearish. Property purchased with the intention of capital gains is very different. These properties are prone to bleeding red ink as soon as they are purchased. During the tenure of the property investment, investors can expect to bring in more money. Cash inflows are only available when the asset is ended, i.e., When the property is sold. Investors may not have the Cash to sustain their profits if there is no exit point. They may need to sell the property at the current market price. Investing for capital gains is not feasible due to such distressed sales.
Tax Efficient: Cash flows are far more tax-efficient than capital gains investments. Most countries have capital gains laws that make it challenging to flip properties without causing a significant loss in taxation. The tax benefits of rental income, which is the heart of any strategy that relies on cash flow, are substantial. The rental income can be used to offset various expenses for investors. Investors can reduce their income and pay lower taxes due to decreased payment. Rental income is also taxed lower because it accumulates over many years.
Capital gains, on the other hand, are taxable as income in one go. Investors who have higher incomes are subject to higher taxes. When investors make capital gains on a property, there are certain deductions that they can take. These deductions do not reduce income as efficiently as those available when the property is rented.
Riskiness: If the risk is defined as a deviation from the norm, capital gains investing is much riskier than cash flow investing. Real estate is prone to fluctuations in capital values. But, the rental value shows a predictable appreciation between 8% and 10% per year. The rental market is, therefore, less volatile. An investment based on cash flow projections for the rental market is less risky than investments based on future capital value. Investors also have greater control over rental deals than capital values. Investors can make improvements to property and improve rental prospects. This is not true for the capital value of a property.
Opportunities in Bear Markets
It isn’t easy to find properties that generate positive cash flows. These properties are only sometimes advertised on the newspaper’s first pages. These properties can be found by spending considerable time searching for bargains. These bargains can also be found in bear markets, such as during the 2008 subprime crisis. This period saw an increase in foreclosures. These people are now without homes because they are being sold on the market at a bargain price. On the other hand, these families want to rent apartments so they can live there. The rental value of apartments continues to rise despite falling capital values.
In such difficult times, sophisticated real estate investors ensure they have enough Cash to buy properties and make deals.