What is cash flow, and why is it such an important factor when making decisions on what kinds of assets to invest in?
When we talk about cash flow, we refer to the money flowing in and out of a business within a specified period. When applied to investing, cash flow refers to the amount of cash generated by the different assets in your portfolio and how much cash has gone into those same assets.
Positive cash flow means that the investment is generating cash. But if the cash flow is negative, you are sourcing cash from alternative sources and putting that money into the asset. For most investors, the primary goal of investing is to generate positive cash flow.
Understanding cash flow is important when designing an investment portfolio to serve as the bedrock of your retirement plan. You want assets that generate enough cash to let you continue your current lifestyle in retirement. To some extent, every asset in your investment portfolio can generate income, but not all assets sustainably generate revenue for the long term.
To get cash out of most assets, you have to liquidate the asset by selling it. This kind of asset is self-depleting. The best assets that create positive cash flow are those assets that can generate cash without any need to liquidate them. These are called income-generating assets.
Building a real estate portfolio for sustainable wealth
Owning rental properties is the most efficient and most reliable way to build a portfolio of assets that will generate a steady supply of cash in the distant future. Multiple, well-managed rental properties in the right locations are the foundation for a retirement lifestyle not threatened by economic factors. It is best to market your apartment buildings and other rental properties to get here.
As long as they are in high demand and properly maintained, rental properties can generate significant income for their owner over time. The value of a rental property lies in its ability to meet a basic human need, people’s need for a comfortable home.
Additionally, unlike most asset classes, the value of a rental property is not easily affected by inflation. As inflation raises the prices of goods and services in an economy, it also forces the rental rate for the property to go up. As a result, the rental income from your property is able to keep up with the inflation rate.
Important factors when investing in rental properties for cash flow
There are four things you must keep in mind when looking for rental properties with the potential to generate positive cash flow predictably over the long term:
The first and most important criteria when buying a rental property is its location. The best areas will have specific qualities that make them attractive to many potential renters.
These qualities may include job opportunities across various industries, the presence of good schools, multimodal transportation, shopping or entertainment center, and low crime rates.
The state of the rental market in a location is another critical factor. A property may be located in a good area, but if there is insufficient demand for that kind of property due to competition, you might not want to invest in that location. If landlords are offering incentives to tenants, do not buy in that location. Wait for a better time to invest in the location or look for opportunities elsewhere.
3. Your costs
Running a rental property includes the cost of capital (mortgage payments and interest), maintenance and repair costs, taxes, professional fees, insurance, and many more.
If you don’t know how much it will cost to operate and how much income it can potentially generate before you buy a property, you really can’t know if that property will be profitable or not.
Appreciation is the rate at which a property’s value increases with time. Although your primary motive for buying the rental is to earn rental income, you should still watch the possible appreciation.
You can utilize the equity in your owned properties as capital to finance other rental properties. The rate at which your property appreciates determines how quickly you can do this.
What kind of rental properties should you buy?
There are several different types of rental properties: residential and commercial. The kind of rental property right for you depends on your location, level of expertise, capital, and investment objectives.
- Single-family homes are where most investors start. They are easy to buy and often more profitable because there don’t need a property manager.
- Multi-family homes let you invest in several income-generating assets at once. Their shared facilities make them convenient to manage.
- Studio apartments are a great option in locations with a high population of college students and single young adults. They are usually low maintenance.
- Apartment buildings enjoy high demand but buying and managing them can be challenging if you are just starting.
- Commercial properties are by far the most profitable rental properties in which to invest. But these types of investments are more complicated.
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