Founder and CEO of Will To Capital (W2C), Real Estate investments management firm based in Barcelona, Spain
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When you think about real estate investing, two types of investments probably come to your mind: cash flow or capital gains. But what are exactly these two types of investments, and why are they so different? Let's take a look.
Cash Flow Investments: When you invest based on cash flow, your investment will be based on the return on investment (ROI). In other words, you will invest by basically considering how much your investment will pay you back every year. For example, if you invest $100,000 in a property and it pays you back $8,000, you will have an 8% ROI. Good cash flow investments are not easy to find and are usually long-term investments, which means that selling the property is not a short- or mid-term goal. In the majority of cases, properties will never be sold using this type of investment, as the only goal is to keep the properties and increase the cash flow by increasing the value of the property.
Capital Gains Investments: The goal of this investment is to buy low and sell high. In other words, you buy the properties and then flip them and make a profit on them. Here, we can find basically two types of flippers:
• Investors who just buy and flip: Their investments are based on speculation.
• Investors who buy, fix and flip: In this case, the investor adds value (capital expenditure, or CAPEX) on the property, which can be high (build new homes) or low (small renovations). The investment is a mix between speculation and added-value investment.
In capital gains investment, ROI is also taken into consideration. When you invest to flip, usually the ROI is higher than in cash flow investments, but it is also riskier, as many times your success is based on the market fluctuations.
So which one is better? In my opinion, there is no worse or better option. What you expect of your investments will determine the kind of investment that fits you best. Here are some tips and inputs to think about:
1. Level of risk: Capital gains are riskier, as you are more exposed to market fluctuations. On the other hand, if the deal is successful, you will make more money and faster in capital gains investments.
2. How fast you want to start recovering money: Cash flow investing often starts paying you back the same day you buy the property, while capital gains will pay you back later. In some cases, a capital gains investment can generate cash flow, but if the goal is to sell it in a short period of time, then think about capital gains investment, not cash flow investments.
3. How technical the investment is: Usually, cash flow investments are more difficult to find and much more complicated to manage. If you don't know how to manage a property, it can ruin the cash flow that it generates. On the other hand, when you buy just to flip the property, you need to take into consideration the buying and selling price and can avoid some technical management concepts like CAPEX, depreciation, taxes, etc., that are essential for good management.
4. The "easiness" of capital gains: We all know someone that bought a property cheap and sold it much more expensive, but are you also aware of the people who lose tons of money buying the wrong property? Capital gains can be very lucrative but also catastrophic if you do it in a nonprofessional way.
5. Refinancing: While cash flow investments are easy to refinance, as the cash flow will pay the money leveraged, a typical capital gains investment that doesn't generate cash flow will rarely be refinanced by a lender.
Keep in mind that good advice, including legal and financial advice and getting different investment approaches and strategic options tailored to your particular situation, is an important element in enhancing consumer and investor confidence.
The information provided here is not investment or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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