September 18, 2020
Joe Fairless

Why Cash Flow Trumps Capital Gains – But Why Not Have Both?

Being a successful long-term investor takes knowledge and commitment. One of the best routes that investors can take to develop their passive income and overall capital is passive investing in real estate. While this is a select investing category, it comes along with a lot of different investment approaches.

Capital Gains Strategy

The capital gains strategy can be summed up as the art of buying and selling assets for a profit. To be successful with this passive investing strategy, you need to be able to identify undervalued assets quickly. This particular strategy is not about speculating on assets. Rather, it’s about knowing clearly the value of the asset compared to the market value.

A Quick Example

To help you better understand the capital gains strategy, let’s look at an example transaction. You purchase a single-family home for $150,000, knowing that it will sell for more on the current market. Then, you sell the home for $200,000. You’ve essentially made a gross profit of $50,000. You knew the home was undervalued. So, you purchased the home and resold it for the known market value.

As you’ve likely learned, knowing the value of the assets in the real estate market is key to your success. With the capital gains strategy, many individuals will pick a particular sector of this market to research and create their knowledge base around. For example, they may invest in only single-family homes, or they may invest in commercial buildings.

This Is NOT Speculating

One of the biggest misconceptions about the capital gains strategy is that it’s all about speculating. That’s not based on any truth. This strategy is about knowing the value of an asset. It’s about understanding the market. You’re not just hoping the property’s market value appreciates over time, as most properties do. Rather, you have information to back up that theory.

For example, let’s say that you know there is urbanization planned for a specific area in the coming year. You know that urbanization will bring in more people and increase the value of properties in that area. Therefore, your capital gains strategy will likely be to invest in properties just before the urbanization takes place. Then, you’ll see the urbanization through, and your properties will increase in value.

Eventually, you’ll sell the properties when they reach your desired selling price. This desired price will highly depend on your capital gains strategy. To help you to get the best price out of your assets, here are some tips you should always be following:

  • Only sell when your reason for buying the asset no longer holds true. Just because your asset increased in value doesn’t mean you should sell it right away. Rather, hold onto your asset until the reason you bought it no longer applies. For example, if you bought a property pre-urbanization. Hang onto it until the urbanization is completed, and the prices are stagnant.
  • Don’t sell just because the market is down. It can be very tempting to sell when the market goes down as you’re ensured some profit instead of none. However, the market always tends to fix itself with time. So, don’t let the market woes influence your selling decision.
  • Don’t ever speculate on profits. It would be best if you never let analysts talk you up on buying assets that don’t meet your investment criteria. You really must make sure that the asset is undervalued before you consider purchasing it.
  • Research, research, and research some more. Being a successful capital gains investor means knowing your market. To know your market, you’re going to have to invest some time doing some diligent research. Please don’t fall into the pitfall of purchasing a property because you invested a great amount of time researching it. Go into research knowing that you’re only going to take action on about 10 percent of the properties.
  • Always have cash flow to maintain discipline. Without cash flow, you may find yourself backed in a corner. The capital gains strategy requires diligence and patience. You need to have cash flow to continue investing and keep you from making unintelligent decisions regarding your investments due to lack of funds.

Cash Flow Strategy

The cash flow strategy is one that every passive investor must be putting into practice regularly. Cash flow investing is defined as the act of purchasing an asset and holding onto it with the expectation of a constant return. This return may be monthly, quarterly, or even annually. The point is that you expect to receive a consistent return at specific intervals that you know about before the purchase.

The return that your receive from the cash flow strategy may be in the form of dividends or rental income. The idea behind this strategy is that it allows you to build resources with a steady income over time. It’s commonly thought of as the retirement building strategy. However, it’s a great strategy for building capital and consistent passive income.

It’s All About The Long-Term

When it comes to the cash flow strategy, it’s all about long-term prosperity. Unlike other types of investments, you’re not focusing on the short-term movements in your market. This is ideal for newbie investors as they don’t get caught up in the panic of short-term market fluctuations and make illogical decisions regarding their assets.

As a cash flow passive investor, you don’t have to worry about timing the market to make a profit. You’re simply putting your money into earning a steady income from the asset over time. You don’t need to worry about factors like capital appreciation like you would with the capital gains strategy. This is what makes cash flow buying such as prized strategy for newbies in the wealth-building world.

It Still Takes Research And Planning

While the cash flow strategy is more newbie-friendly than the capital gains strategy, it still takes diligent research and planning to be successful. You must consider the potential state of the asset and future cost investments to keep it in prime condition. Your future income must be enough to sustain the asset’s maintenance alongside providing you steady cash flow.

You’ll also need to take into consideration the future earning potential of the property. Not all investments are good investments. You may find a property has great cash flow right now. However, it needs to continue that cash flow long enough for you to recoup your initial capital. Factors like natural disasters, civil unrest, and unemployment all need to be considered.

It’s best to stick to areas that naturally attract residents. Areas that are peaceful and have a plethora of employment opportunities. The cash flow strategy is all about ensuring that your long-term income will be there. When doing research, you’ll want to dismiss properties that are located in areas with high rates of civil unrest or few employment opportunities. These are indicators of significant risk for the property and your future income. Here are some other tips you should follow with the cash flow strategy:

  • It’s not all about the yield. While some properties may have a very high yield, they may not be going into the future. You need to assess the longevity of that yield before you make a purchasing decision.
  • The debt matters. When you purchase an asset, you need to consider the debt you’re using. Your strategy should include a proper payback for that debt. Also, realize that buying properties via debt can reduce your earning power.
  • History is a big indicator of the future. When you look at real estate, you’ll start to notice that history tends to repeat itself. Use this knowledge to asset past property history to see what it reveals.

Cash Flow And Capital Gains Are Keys To Passive Wealth Accumulation

Now, you should have a pretty good understanding of both the cash flow and capital gains strategies. While you may initially favor one over the other, the truth is that both are ideal for any passive investor. The cash flow strategy ensures that you have a steady income. The capital gains strategy allows you to build wealth at a faster rate when executed correctly.

Passive investing is all about making money for both the short-term and the long-term. While you can invest your time in purchasing assets for reselling later with the capital gains strategy, you’re still going to need income. That’s where the cash flow strategy comes into play. It ensures that you have a steady income to continue practicing your capital gains strategy.

Remember, you need steady income, so you don’t get backed into a financial bind. When you have consistent cash flow coming in, you can make decisions regarding your capital gains strategy with ease. When you don’t have the cash readily available, and you’re in a financial bind, it can lead to illogical decision-making. These illogical decisions are what kills many passive investors. Do yourself a favor and utilize both the cash flow and the capital gains strategy in harmony to ensure your best chance of success in building the wealth of your dreams.             

Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.

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