Cash Flow vs Capital Appreciation from Investment Property
Working capital cash flow verses capital appreciation is an age old question all property investors face. Should one purchase a property focused only on cash flow, only on appreciate, or a mix of both. Let’s first look at a few examples of what cash flow and appreciation are to further understand the benefits of each.
Cash Flow in its simplest form is the gross amount received minus any expenses to maintain the asset. For example, if you lease a property for $1000 per month, and your mortgage, taxes, repairs and management fees to maintain the property are $700, then your cash flow would be $300 per month, or $3600 a year. In this situation, you would be cash flow positive or positively geared. If your expenses were $1100 to maintain this property, then you would be loosing $100 per month, and would be in a negative cash flow situation, otherwise known as negatively geared.
Appreciation is the increase in value of the investment property over time. For example, if you purchased the investment property for $150,000, and ten years later the property value of the home was $245,000, your asset appreciated $95,000, or an annual appreciation rate of 5%.
Now let’s dissect the cash flow verse appreciation situation above. Let’s assume we held the property for the full ten years and then sold off the property for the appraised amount of $245,000. A $3600 cash flow over ten years would of gained you $36,000. The $96,000 appreciation gain however is almost three times the amount gained from cash flow alone. In this example, appreciation should clearly be the focus, with trying to maintain positive cash flow if possible.
If the area you are purchasing investment properties in does not appreciate between 5% – 8% a year, then cash flow is most likely the better answer. Just remember that there is really only one way to increase cash flow, and that is to raise rent. It is very difficult to cut net operating costs on investment properties in order to increase cash flow. This is important to keep in mind when searching for an purchasing investment properties.