How is cash flow less risky than capital gain?

Question

I am a beginner who tries to start a real estate investment. After I read several books about real estate. When I was searching what is the best way to invest, the first thing which caught my interest was BRRRR investment. Honestly, flipping doesn't seem to be my type. I wanted a more stable income all the time even it is a tiny amount. The cash flow which Mr. Kiyosaki explained was really attractive to me. But I have one concern. Is cash flow really less risky than capital gain for the long term investment? I read that some say that cash flow is stable even the economy goes down or gets trouble. Ok, this is an extreme example. When the price of property extremely goes down or gets plummet, I doubt that the price of rent would not get the effect from it. A tenant could stop renting anymore or no one could be willing to rent because of the bad economy. So the reason they say cash flow is less risky doesn't sound reasonable for me. I am curious why and how it can be exactly less risky than capital gains. Oh, don't get me wrong. I don't think cash flow is out of risk! I just want to know how it can be less risky than capital gains as people say. Thank you for reading.

Jaron Walling · Answer

That's an interesting way to think about it but cash-flow doesn't fluctuate like you think. Tenants sign a lease that requires them to pay a set amount each month. That's good for cash-flow but more importantly it's security for your investment and anyone living in the property.

Rent rates do not correspond to the price of houses. Just because the market crashes and values drop X% doesn't mean rent drops. In fact there have been times rent rates increased because people stopped buying and couldn't qualify for loans.

Dave Spooner · Answer

@Junho Jeong Appreciation is great, but it's far from a guarantee. Relying on cash flow of course requires you to keep your property rented, but typically, that's not very hard. Sure, maybe you have to go below your target rental price, but unless you purchased in an area in which truly no one wants to rent, you can always find a renter. Selling in a market in which no one wants to buy has a bigger cost.

And it may seem like properties always appreciate and at a pretty steady rate, but in reality, there's quite a bit of spread between markets. Here's a pretty insightful graph from realestatedecoded.com:

Those are big differences. If you focus on cash flow, you'll always be able to pay your mortgage. If you focus on appreciation, you may be banking on value that will never come, and that can be a huge risk.

All this being said, it ultimately depends on your market. If you're market is appreciating in a really substantial way and you don't foresee any issues, or if you see an opportunity for a great buy and quite a bit of forced appreciation, you can adjust your approach.

Patrick Desjardins · Answer

Try to strike a balance between both. To answer your question, as others pointed out, cash flow is considered safer because even though you might not be able to keep up with repairs etc, at the minimum you'll be able to pay the mortgage and benefit from that long term loan paydown.

HOWEVER, it's undeniable that people who caught the wave after the previous recession, in strong appreciation markets, did way better than people focusing solely on cash flow. I have some in Memphis and they gained a little value, but nowhere near what I would have made in Florida, California etc.

So my advice would be either balance your portfolio in 2 markets, one with strong cash flow and the other with more appreciation, or go for one of the markets that have a little of both. Just my thoughts, maybe others disagree.

Scott Passman · Answer

In the case of a recession/depression the pool of renters would actually increase, not decrease.  In down economies, more people are unable to buy homes because lending standards tighten, costs of home ownership are too high, people get scared to make a major investment in economic uncertainty etc.  You also see more people lose their homes to foreclosure because they can't keep up with their mortgage payments.  All these people still need to live somewhere, and thus more people turn to renting rather than buying in bad economies.  Because of the increased demand for rentals,  you sometimes see an increase in rental rates as @Jaron Walling mentioned because you have higher demand for rentals since fewer people are buying homes.  This is why cash flow is more stable and predictable compared to appreciation because in a good economy rates go up and in a down economy rents usually stay stable.

Andy Mirza · Answer

@Patrick Desjardins I think that's some good advice. I'm in favor of diversifying assets to reduce the risk at all levels. It's also nice to benefit in different parts of your portfolio as some areas or asset types do better than others. If I get at least a little bit of an unexpected bonus from time to time, I don't get FOMO

Junho Jeong · Answer

Thanks all of you for answering my question and helping me to quench my doubt!

Kenneth Garrett · Answer

@Junho Jeong

During the 2008 crash rental rates increased slightly and because on the onslaught of foreclosures more people need to rent which increased demand which increased rent rates. @Jaron Walling and @Scott Passman bring up great points.  You would think there is a correlation with real estate values and rent amounts but they are mutually exclusive. The 1% rule might throw you off.  That’s why you should only consider that as a guide.  When analyzing use actual numbers to the best of your ability.

Great question.

How is cash flow less risky than capital gain?

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