13 Feb Cash Flow vs Capital Gains Investment Income
Real Estate Investing for Cash Flow or Capital Gains Investment Income – Or Why Not Both?
Real estate investors, whether seasoned or new, are often looking for either cash flow or capital gains – or both. The one aspect of real estate that is so compelling is the various ways you can achieve cash flow or capital gains.
Real Estate Capital Gains Investing
Most real estate investors start out with capital gains investing, which is basically buying properties low, increasing the property value, and selling the property for a higher price.
By investing in real estate assets that you are going to quickly sell, you are able to (usually) generate a better ROI, but with stronger returns come potentially higher risks too. This is a great way to generate large sums of capital, but let’s talk about some of the risks.
For one, you’ll want to make sure you’re buying, say a single-family home, at a substantial discount. The old adage in real estate is still true today for real estate capital gains investors: “you make your money when you buy”.
Secondly, you’re usually floating a lot of money before you get paid such as the down payment to purchase the property, the CAPEX or rehab costs, contractors, permits, and various holding costs including the mortgage, interest payments, utilities, property taxes, and insurance. These costs often come out of the investor’s own pocket from their cash reserves until they sell the asset.
Other Challenges with Capital Gains
The other challenge with real estate capital gains investing is that it is an active form of investing meaning you will need to “rinse and repeat” to continue generating income. You must be actively finding properties, analyzing properties, negotiating contracts, funding the asset, overseeing the construction plan, permits, and contractors, and then you will need to sell the property to reap your reward.
Additionally, there is always the risk of the local real estate market tanking and real estate investors being unable to sell their flips as we saw in the 2008 Financial Crisis.
You also want to watch out for capital gains taxes. If, for example, you sell your asset within a year, you will have short-term capital gains which are taxed as ordinary income. If, on the other hand, you hold onto your investment properties for at least one year and one day, you will be taxed on the long-term capital gains rate, which would be a rate of 0%, 15%. or 20% depending on your circumstances.
Stock Market Capital Gains Investing
This is what most people do for their investment and retirement strategy – they put money in a brokerage account, a 401K, IRA, a mutual fund, and hope for the best. They basically let Wall Street take their money and invest it for them.
I remember reading the book “The Big Short” by Michael Lewis years ago, and it was an eye-opener about how some investment firms on Wall Street put newbie college grads in charge of people’s entire life savings, and how these “investment experts”, in some cases, have no idea what they’re doing.
Many people invest in Wall Street simply because they don’t know where else to place their capital. This is oftentimes because they weren’t taught how to invest and manage their money.
Financial Literacy in the US
We have a financial literacy crisis here in the United States that can only be corrected with a fundamental, comprehensive financial education that must start at the elementary grade level, at the very least. But I digress.
The risk with stock market investing as your only investment strategy is that when the stock market is accelerating, it’s great, and when it is decelerating, it’s a horrible and helpless feeling for investors.
There is definitely a place for stock market investing for a portion of your portfolio – but just not for all of it, and that’s what, unfortunately, most people do is put all of their money in the stock market instead of diversifying into, say real estate.
Cash Flow Investing
Cash flow income is considered to be passive income, the lowest taxed income – which is not always the case with capital gains income because it varies by investment and the hold term.
Cash flow investment opportunities are a “set it and forget it” type of real estate investing. When you invest in this type of investment, you can expect to receive distributions every month, quarter, or year.
With cash flow investing, you want to understand what your ROI is on your investment. So, for example, if you were to invest $100,000 in a commercial real estate syndication and your preferred return was 8%, then you could expect to receive an ROI of $8,000.00 per year on your investment. The preferred return determines how much cash flow you receive.
Unlike capital gains investing, cash flow investing can be more predictable at the outset. Never guaranteed, but more predictable.
How Do The Wealthy Invest?
This is how the wealthiest among us become so. They don’t trade their time for money, they have their money always working for them. This is counter to what the majority of individuals in the world are taught. Good financial literacy teaches you the importance of cash flow investing.
Investing passively in real estate not only provides for investing in a tangible asset (unlike paper assets), but the type of real estate investments we seek are real estate syndications in affordable housing communities, which are in very high demand and are a much-needed housing option for Americans.
Additionally, real estate provides outstanding tax benefits that other investments don’t, which can help you grow your wealth faster.
Benefits of Cash Flow Investing
One of the other benefits of cash flow investing is that because it is typically a longer-term investment, there are fewer concerns about downturns or fluctuations. If the investment has proved historically to do well even in downturns, which affordable housing has to this point, then it can be a much safer investment for the short term and the long term.
“Buying real estate is not only the best way, the safest way, but the only way to become wealthy.” – Marshall Field
“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” – Franklin D. Roosevelt
“Every person who invests in well-selected real estate in a growing section of a prosperous community adopts the surest and safest method of becoming independent, for real estate is the basis of wealth.” – Theodore Roosevelt
Why Not Incorporate Both Investment Strategies: Capital Gains and Cash Flow?
If you’re wondering how you can find the extra capital to passively invest in a real estate investment for positive cash flow – well, you can use a self-directed IRA or Solo 401K (a.k.a. QRP) or convert an old 401K from a former employer.
You can generate the capital through various capital gains strategies such as buying a fix and flip, rehabbing and selling the investment property, taking the profits, and investing them into cash flow properties such as real estate syndications to start receiving passive income distributions on a regular basis.
For example, one cash flow strategy would be to use your QRP to invest in the fix and flip, the profits would go back to your QRP – TAX FREE – and you could reinvest that capital into a passive income real estate opportunity.
Real estate, in general, can provide you with one of the fastest ways to hit your financial goals to ultimately allow you to live the life of your dreams – on your own terms.
Real Estate Syndications Provide Both Capital Gains and Cash Flow Investing Strategies
One investment strategy is not necessarily a better option than the other. But smart investors will often combine both strategies. You can get both cash flow and capital gains investing advantages in one investment opportunity – a commercial real estate syndication.
By investing in a commercial real estate syndication, you get to receive regular passive income distributions and you receive a portion of the equity profits through the market appreciation and forced capital appreciation conducted by the sponsor team, the property manager, and their team as well as the asset managers during the hold term of the asset.
What is the Goal?
The goal of these teams is to put out capital expenditures so that there are capital improvements made to these commercial properties with the intent and objective of increasing the value of the property for all of the investors. The increased market value allows for a sale at a higher price and so, of course as a result, greater returns to the investors.
Real estate syndications are not necessarily long-term investments but they are not necessarily considered short-term investments either. A commercial property in a real estate syndication is usually sold, in the majority of cases, within 5 to 7 years.
So, the best way to grow your wealth is by having your money work for you by receiving your passive monthly cash flow Or it can be quarterly cash flow. Or it can be cash flow that you receive on an annual basis. Then you get the large lump sum of cash from the appreciation or increased value of the asset when the asset sells. You can reinvest that capital if you wish to be continually growing your capital to meet your financial goals.
As with any investment you will want to conduct your own due diligence on all types of investments whether they be cash flow investments or capital gains investments.
Note: We are not acting as a financial advisor, and are not providing financial, tax, or professional advice of any kind. Please consult with your advisors before making any financial decisions. The information we provide is for educational purposes only.
Until next time, Earn Passively & Live Abundantly!
Ready to Learn More?
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