Cash flow can help you quit your job, but equity makes you truly financially free. What will your focus be for your next BRRRR?
Buying a property under market value is a must for any investor and is where any good investment begins. Whether buying for cash flows (i.e., rental income) or appreciation (long-term increase in the value of a property), that core concept of getting a great deal at the start never changes.
What you buy though, particularly the class of property you buy, really comes down to a discussion of goals. Is your focus on getting the most rental income you can per month or are you interested in the long-term play of potentially sacrificing some current rental income for appreciation and growth as the years add up to greater financial freedom in the future? There is no right answer, but we argue that if you have the flexibility in your life circumstances to focus on appreciation the rewards will be much greater financially than purchasing as a cash-flow focused investor.
Equity Building through Real Estate
There are many real estate investors for whom the question of equity versus cash flow proves a bit of a stumbling block. After all, with real estate investing, the goal is always to make money and generate the highest combined return on investment in the form of accumulated appreciation and cash flow. On balance, they are the primary ways that returns are enjoyed on any sort of real estate investing activities. But where should your focus be when investing in real estate and making a purchase decision – long-term appreciation or current cash flows?
For any real estate investor, both appreciation and cash flow are important, and we do not advise completely ignoring one at the expense of the other. That said, which of the two you prioritize will depend on your investing goals. It comes down to this – if you are buying for appreciation (i.e., buying properties at discounts to market value in areas likely to appreciate and grow over time even where say rental income is not as high as it could be in other areas) you are a long-term investor. If you are buying properties (generally in less desirable areas) with the goal of bringing in as much current cash flow as possible you are taking a shorter-term “I am looking to replace income from my job” approach. Both have their benefits. But, if you have the luxury of playing the long game – say you enjoy working and do not have strong desires of an early retirement – buying for equity is the way to go. Let’s look at the math.
The True Value of Cash Flow
Let’s say you can get a house in a “C” or “B-” neighborhood that cash flows great. We can pick a number of $200 a month in cash flow. So every year you are bringing in $2400 a year in cash flow, something that would make most investors happy. But what does that $2400 a month really cost you if say you could instead have that investment in a better class of property that is more likely to appreciate over time? What if you could instead buy a fixer upper in a better neighborhood for an after rehab price of $200K that was appreciating at 5% annually? Well, in the first year alone you would increase your long-term equity in the property by $10,000 and hopefully still cash flow even if a bit lower than the $200 a month in the lesser appreciating area…you can start to see how purchasing for quality can have a much greater impact on long-term wealth than the property with the more exciting monthly payment. Less truly can be more in your real estate portfolio.
As a further illustration of this point, the investor looking to recover $5k to $10k on a single instance of real estate investing typically needs from 2.5 to five years of “after tax cash flows” totaling $2k per year to hit that goal through the cash flow focused model.
On the other hand, the use of appreciation as your primary method for profits from real estate investing could feasibly see your net worth increase exponentially in five years, and from an initially modest investment strategy. How much? A very limited number of acquisitions (say two properties per year at purchase prices of $100,000) at 5% appreciation could grow to almost $260k in aggregate net worth in those same 60 months, not to mention your cash flows in those properties over that same period. You are also likely to see a better base of tenants applying for these types of properties – having the right tenants is crucial to managing the expenses related to rental properties.
BRRRR Strategy and Its Income Potential
The buy-rehab-rent-refinance-repeat (BRRRR) strategy is a form of rapid-fire real estate investing that adheres to the idea that your wealth grows based on the velocity at which you can deploy it into more and more projects.
To quickly define the BRRRR strategy – buy a great deal on a property, increase its value by fixing it up, lease it to a tenant, find a bank to issue you a loan on the property at a high percentage of its after rehab value (ARV), use the loan proceeds to buy more properties, and repeat the process.
Simply stated, we believe the BRRRR strategy is for those more interested in equity building rather than in cash flow.
Why? With the BRRRR method, you can get lots of properties using the same cash you first invested in real estate in a relatively short period of time by constantly buying, refinancing, and buying again. The faster you get a return on your initial investment, the faster you can put it to use in the next deal and the one after that, and so on. Cash flow, on the other hand is a waiting game, a matter of time passing in order to accumulate wealth or realize a substantial return.
That said, BRRRR can, however, impact monthly cash flows because you are adding a mortgage that must be paid down (hopefully by your tenant of course) with each refinance and the related payment for that mortgage will be taken out of regular monthly income, leaving less current cash in your pocket at the end of the month. But, does that matter if BRRRR gives you the benefit of rolling the same cash into project after project? Can you sacrifice in the short-term for huge returns in the long-term?
Decide what Financial Freedom Looks Like to You
So you have to ask yourself, and it will be personal for each person, what are my real estate investing goals? Accumulate many great properties that may pay not pay me my “ideal” cash flow in the near-term but that are most likely to appreciate and generate real financial freedom for me in the medium- to long-term, or focus on that immediate cash flow. We opt for the former – but maybe that cash flow is what most attracts you to all of this. We just want to make sure you have all factors in mind when making this important investing decision.
What Common Advice Indicates
If you listen to many of the real estate investing advocates, it is all about the cash flow. Why? It feels faster and is all about the “surplus” of rental income generated every month. The appreciation naysayers will often argue that using an appreciation-based approach is riskier because it takes years to generate substantial returns, and that an investor might struggle with their costs over the period before a measurable return on investment is secured.
However, this is a shortsighted stance on appreciation, especially if done using the BRRRR strategy.
Re-Evaluating the BRRRR Strategy from a Risk Perspective
Buying, rehabbing, renting, repeating and refinancing are the key components used in the strategy. However, behind that seemingly simple formula is a lot of work. For example, in one of our recent blogs, we see this simple and clear statement about BRRRR: “If you apply it effectively – which really only requires buying a property under value and doing enough rehab to drive up its cost – after just a short time you will end up owning a home with a tenant who is providing you cash flow and will have, through the process of the bank refinance, recouped all or close to all the cash you used to buy and rehab the property.”
It is that last part that is most relevant to the debate about which is best – appreciation or cash flow – in real estate investing. It is the part that explains that the BRRRR method allows almost immediate and full recovery of the monies used to both purchase and increase the value of the property. It puts all of the funds right back into your hands and does not require that you wait many years to continue growing your real estate portfolio.
It does require the research. Your main job is to first find properties worthy of the investment and then get the best deal possible on the properties. You must then invest enough to make them appealing to renters, and then head to the bank to finance that property and put the loan proceeds to work in your next venture.
Cash Flow Focus Can Be A Risk?
Cash flow is just that, a flow of cash that you can pre-determine through your research. It will come in at a steady pace and is determined with a very simple formula. It requires the gross income or rent minus the total expenses (mortgage, insurance, taxes, repairs, and so on). The goal is to have the net exceed the expenses (and any other costs associated with ownership of the property). It does put money in the owner’s pocket.
The big problem or concern is with how much money it puts in the owner’s pocket, and how fast it enables them to redeploy that income. Determining how much in potential earnings a property might generate is fairly simple when looking at the price to rent ratio. Some locations have home prices that make it wiser to own than rent, and this would be a poor option for those looking at real estate investing through the cash flow model.
Yet, even when a decent amount of cash flow is possible from a home purchased, rehabbed and rented, if that is where your steps in real estate investing end, it just won’t generate money fast enough to make it the strongest strategy for the repeat investor.
Imagine also the situation where you choose cash flow over appreciation and find yourself in a lesser quality property with a careless tenant who damages your asset. One major issue and the cash flow you were hoping for is going to be depleted substantially. We do not want to see that happen to your real estate portfolio
The BRRRR Method Applied for Appreciation
Earlier in this article, we noted the tremendous potential for growth when focusing appreciation over cash flow. We should look at that again now to provide another example. For our example, we’ll say that you have $100k to invest and you invest in a market where appreciation is around a modest 3% per year. Your BRRRR strategy would look like this:
In just five years’ time, this method would generate remarkable results and it would be entirely possible to find yourself the owner of a substantial number of properties generating cash flow via rental income, and also accumulating substantial value based on appreciation. Your net worth would increase rapidly, and would be operating at little to no risk because you will have done the research and made the investments that made good sense.
BRRRRInvest has tools and resources necessary for creating and building your portfolio. BRRRRInvest is an all-in-one service that provides BRRRR investors with a long list of resources essential to success in BRRRR investing. With our rapid analysis capabilities, and attorney-prepared, investor-friendly contracts for hiring your team and leasing to your tenants, we can help first-time and long-time investors make the most of any opportunities. Check it out!