People constantly ask this question. If you can only have one, is a project great if it produces a bunch of cash? Or is it great if it builds equity? Let’s get some boring definitions out of the way before we answer.
Cash Flow: The ‘profit’ of the property. This is the money left over when every last bill, tax, insurance, and mortgage payment attached to the property is paid out. This is your take-home money, or what the property pays you for your investment of time, work, and money.
Equity: The amount of money in the property, or that money you would get back if you were to sell the property today, after paying back all the bills, taxes, and mortgage.
Which is Better for My Wallet?
Depends on your goals. Perhaps you are just starting out. You have a little money saved up, but not much. You can buy one or two properties and you plan to put a lot of labor into them to repair and manage. You’d like to quit your job.
If this defines you, then your goal is to maximize cash flow. You are early in your career, and you can afford to wait for those properties to go up in value to you (equity). You can’t afford to have a property that loses money every month. You can’t even break even, because you’ll never be able to invest in more properties. You need cash flow, preferably from day one. If you get enough cash flow, you’ll be able to survive without your day job.
To you, equity is great, but it is just another avenue to pull out money to buy the next property with a line of credit. Your challenge will be in competing with investors who have more cash and can put it all in to reduce their mortgage payment. They will be able to pay more for a property than you. They typically won’t want to put in as much work, so you would be smart to look for those value-add properties that you can fix up. The bottom line is that you are looking for cash flow and will want to prioritize that over equity.
On the other hand, maybe you have a lot of cash. Maybe you are a high-performer. You don’t have a lot of time to be repairing properties yourself, but you do have money. You probably have a large monthly paycheck and you pay a lot of income taxes. Your concern is with minimizing these taxes for now, so that later, when you don’t have that income (retirement), you can pull out money. You’d rather defer the profits now, and take them in the future. You want equity.
If this is you, then you will be looking for places to park your cash that don’t get taxed. Equity in a property is a nice way to do this. You’ll be willing to pay more to purchase a property. You’ll be interested in setting up your mortgage (if any) so that it is a little more than cash flow neutral, meaning it has a little profit, but not much. What would have been cash flow will now be going into building equity.
Readers of this blog are high-performers and likely will be in the latter category. They want to build equity and don’t care as much about making an extra $100 a month in rent payments. Better to put that $100 into equity and not pay tax on it for now.
So, there you have it. Equity wins. But it’s not for everybody. It is for high-performers. After all, they wouldn’t call me Doctor Equity for nothing.