“Why not both?” might be your retort to this article’s title, and I would surely agree that a real estate investor should seek both cash flow and equity. There’s no reason to settle for just one or the other, of course.
That being said, “focus” is the key word here; or really, “primary focus.” Should the primary focus of a real estate investor be either to gain built-in equity upon purchase or to acquire a property that will cashflow well.
What Are Your Goals?
Right off the bat, it’s important to note that there is no perfect answer to this question. A lot will depend on what your goals as an investor are.
An investor looking to supplement their retirement income should focus mostly on cashflow. A newer investor trying to get their foot in the door should aim more at equity. But again, both are clearly important.
The Cashflow Bare Minimum
The dirty little secret that many gurus don’t want to tell you is that cashflow by itself will not get you rich. If you use debt financing, it will take a lot of properties before the cash flow above your debt service will be enough to live off of and many more before it’s enough to thrive off. The I (Income) in the IDEAL acronym for why real estate investment is such a good investment is just the cherry on top.
That being said, cashflow needs to be there. Buying an investment that won’t bring in a positive cashflow is little more than speculation (especially if the cashflow is projected to be negative). And while there is a place for speculation, it should only be a small part of your portfolio and done with money you can afford to lose.
Positive cashflow prevents you from having to feed money pits so as to keep your reserves strong for the next investment. It also makes it easier to get approved for bank financing.
So while cash flow needs to be there, it’s not essential for it to be huge. It’s nice, but equity is more important.
Built-in Equity Builds Wealth and Reduces Risk
Built-in equity, or in other words, buying properties for less than their worth or adding value through the rehab is the key to real estate investment in my humble opinion.
First of all, you have effectively made a large chunk of money upon purchase. For example, if you can be all into a house worth $200,000 for $160,000 (80 percent), you’ve just made yourself $40,000. If that same house cash flows $100/month, it will take a cool 33.3 years to make that same $40,000!
Built-in equity also allows you to take advantage of the BRRRR method and refinance the property for all the money you have into it. This means, if done right, you can own properties without putting any of your own money into them.
But perhaps most importantly, built-in equity is the best risk mitigation tool a real estate investor has. Whenever you purchase a property, obviously, there is a chance the value will go down. Built-in equity gives an added layer of security to an investor. Even if you fully finance the $160,000 you are in to that $200,000 property noted above, and it goes down 20 percent, you still are even; $160,000 into a property worth $160,000.
Now that’s pretty good security!
Cashflow is important and needs to be there to make sure an investment is stable. But in the end, the most important thing for real estate investors to focus on is getting good enough deals to have sizeable built-in equity positions. That’s how you build wealth with real estate over time.