In real estate investment, there are a lot of variables. The type of property you buy, that property’s location, decisions about whether to manage the property yourself – all of these affect the value of your investment over time. Another point to consider is whether you want to rely on cash flow or equity for growing your investment.
Cash is a liquid asset transferred in and out of the investment. When you have positive cash flow, you can transfer the surplus immediately into another investment vehicle, such as stock, or use it to increase your real estate portfolio. Equity, on the other hand, is tied to the value of the property itself. You need to sell off the holding in order to liquefy your assets.
So when is it better to max out your down payment on the property, and when do you focus on getting the most cash out each month?
When Equity Matters More
For many developers and short-term investors, equity is the only game in town. Developers purchase raw land and construct a new build or rehab an existing commercial property. Whether the investor is a novice home flipper or a billion-dollar real estate developer, the goal is the same – create instant equity by spending less on the project than you sell it for.
Equity can also be more important in some long-term investments, particularly when you are using the property’s depreciation and other write-offs to offset your tax burden.
Long-term investors hold the property as a passive investment, or if they do decide to sell, they use a 1031 exchange to defer paying taxes on the assets at the time of sale. Smart investors can accumulate a great deal of wealth by “trading up” their real estate portfolios without ever having to pay capital gains tax on the equity they earn.
When Cash Is King
For the average person investing in residential real estate, cash flow is almost always going to be the more important variable to focus on. This can be counterintuitive for a lot of new investors, who find security in equity and are motivated to make large down payments on the properties they buy in order to grow their investment faster.
However, what these investors neglect to consider is that, when their assets are tied up in the property, their only recourse when things go off the rails is to sell their property in a hurry in order to free up cash. This can be disastrous in a down market, even costing the investor to lose on their initial down payment in some cases.
The goal for the average investor is to put as little money down on the property as possible and to finance the property for the longest term available. Together, these two measures decrease the monthly payment you will have to make on the property and increase your positive cash flow.
Remember: When you have positive cash flow, you have a hedge against tenants who destroy property or don’t pay rent, short-term changes in the real estate market, and personal catastrophes that limit your income. You can use that cash in hand to tide you over until the situation improves rather than needing to sell the property and lose your investment.
Growing Your Investment with Peak Financial Partners, Inc.
Peak Financial Partners, Inc., part of the Peak Corporate Network entities, is a private real estate investment firm that specializes in a multi-strategy investment approach. They handle mortgage and securities acquisitions, offer equity joint ventures, develop residential and commercial properties, provide asset management services, and acquire investment properties. Working priily, residential, and retail sectors throughout the United States, their capital comes from select private and institutional investors.