There is an age-old debate in the real estate industry over which type of real estate investing strategy should be employed in a down market and which type is likely to work best. Just as a master craftsman selects the proper tool that is specific to the task at hand real estate practitioners also have to employ the appropriate strategy that matches their investment goals and current market conditions. In order to apply the proper strategy-to-market match we first must look at the two basic types of real estate investing. The first is cash flow investing and the second is known as buy and hold investing, both make strong cases for wealth accumulation and perform well in slower market conditions. Let’s drill down deeper and cover the details of each one.
Cash Flow Investing
Cash flow investors seek out properties that produce monthly income and more importantly positive cash flow. In other words they take the approach to buying property just like you would if you were purchasing a business and they run their properties just like a business. Successful cash flow investors take the time to thoroughly verify the financial records of a particular property, they look closely at historical operating data and they don’t pay much attention to pro forma or prospective income projections.
In addition cash flow investors don’t just rely on appreciation for profitability. If your investing strategy is based solely on the anticipation of appreciation then you are more in the gambling business than the real estate business. It is important to understand that appreciation is not guaranteed. Many investors have learned this lesson the hard way as a result of the current real estate recession. Obviously if you have positive appreciation that’s a good thing but cash flow investors realize if they don’t it’s okay because their focus is primarily on income. Another benefit to income property ownership is debt reduction. From each monthly payment made a portion of the payment goes toward principal and this is a good form of implied appreciation. Over time your properties continue to service principal and interest and the yield curve swings more in your favor allowing the total return and net worth to increases every month with every payment.
Income properties also have the ability to weather prolonged market downturns where sales are slow and prices are falling. In markets where foreclosure rates are rising less people can afford homes and less home sales are made. Income properties particularly multi-family apartments are in a perfect position to benefit as the rental market tends to expand during times of increased mortgage defaults.
Buy and Hold Investing
It is often said in real estate that you make money when you buy it and you realize your profit when you sell. No other strategy in real estate is this more apparent than with buy-and-hold investing. This form of investing goes by many names such as buy-and-hold, buy low sell high, flipping and land banking just to name a few. Conceptually the strategy is very simple all you have to do is buy right and sell right. What sounds easy is not often well executed; developers and investors that make mistakes usually become buy-and-hold investors by default. In many cases they aggressively purchased properties just before major cycle downturns. All too often this is the fate of real estate speculators who try to flip properties to make a quick buck and often find themselves caught as buyers pull back and sales soften.
Investors that employ this strategy successfully concentrate on buying properties that are in the growth trend and are generally attached to existing or planned traffic arteries. They understand that traffic unlocks the future value of real estate and values tend to rise where traffic counts are highest. The successful buy-and-hold investor also has a healthy respect for leverage and do not carry high loan to value ratios on the properties they acquire. These type of properties produce no income and it is best to keep debt exposure low usually around 50% loan to value and maintain higher than average overall equity. Detailed calculations are made on total carrying cost such as debt, taxes and maintenance and these projections are planned out for multiple years.
So when it comes to cash flow investing versus buy-and-hold investing basically it comes down to your financial situation and your investment goals. If you are comfortable with less out-of-pocket investment, property management and a lower but predictable return on investment then cash flow investing may be the way to go.
Buy-and-hold investing can be a great strategy to employ in a down market such as the one we have now as real estate prices have fallen considerably in some submarkets. If you have the cash, there is the opportunity to find good deals with favorable terms. Just make sure you have the patience as time and cost have the greatest impact on your potential profits