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October 30, 2019

Cash Flow is King

As another decade ends, real estate’s attraction to savvy investors looking to increase wealth and/or diversify their portfolio continues. There is a reason the wealthiest individuals in the world have a substantial amount of their assets in real estate; the financial benefits are seemingly endless.

Of the many avenues to acquiring profitable real estate are real estate investment trusts (REITs). They provide greater diversification, lower risk, and possibly higher returns than other forms of investing and require relatively lower amounts of money to get started.

No matter what your mode of investing is, there are many factors to consider while looking for real estate investment opportunities that have the potential to yield significant returns. Cash flow is arguably the most important aspect of any financial investment decisions, REITs included.

In this article, we will answer some essential questions and cover a few key points describing how cash flow pertains to REITs.

What is Cash Flow?

Simply put, cash flow as it pertains to real estate is the income generated from renting or leasing a property.

A positive cash flow occurs when there is money left over after paying all expenses related to operating and maintaining a property. Conversely, negative cash flow is present when expenses surpass the income received. The expenses include, but are not limited to, mortgage payments, property management fees, maintenance/upkeep costs, insurance, repairs, advertising, vacancies, property taxes, etc.

Most, if not all, investors purchase a property based on the positive cash flow it produces or will produce as they look to maximize the return on their investment. Many lucrative real estate deals and strategies focus on purchasing a property in need of repair, enhancements, or increased efficiency in management and operations. This is commonly referred to as value-add and it also includes increasing positive cash flow to either produce income or raise the market value of the property for maximum profits at the point of sale.  

Why is it Important to Have Positive Cash Flow?

Essentially, when you’re investing in a cash flow positive property, it is already paying for itself every single month when rents are collected. For individual investors, you don’t have to pay anything out of pocket to keep up your property. As a REIT investor, this means you are generating dividends from day one since the property is already producing income.

Another reason that it’s important to invest in positive cash flow properties is that they are low risk. This seems obvious, but look at it this way– the property is already generating income; therefore you can literally do nothing and still be making money. However, at DiversyFund, we implement a value-add strategy that allows us to generate even more cash flow over time.

How Does a REIT Distribute Positive Cash Flow?

As more and more investors look for ways to create passive income streams via reliable positive cash flows, they are increasingly turning to real estate investment trusts (REITs).

In short, the REIT owns and manages the income-producing property and the positive cash flow that is generated from the rents are distributed to the shareholders. REITs must distribute 90% of their income to shareholders in the form of dividends which contributes to their very high yields and payout ratios. Also, there are some unique tax benefits enjoyed by investors in REITs.

Residential REITs vs. Other Options

REITs can purchase numerous income-producing properties and there are multiple forms of REITs to choose from (health care, office, retail, residential). DiversyFund’s REIT only focuses on multifamily cash flow positive properties. Multifamily homes are separate units that are contained in one or several buildings in a single complex. There are varied types of multifamily homes such as duplexes, triplex, quadplexes, townhouses, apartment buildings or condominiums.

Investing in residential REITs is a much less risky investment due to the strength of the housing market. With the current shortage in housing and the demand for new housing expected to exceed the supply, the outlook for multifamily real estate is excellent for the foreseeable future.

Multifamily real estate has large tenant pools and, even if a unit becomes vacant, there are multiple other dwellings within the property bringing in money to more than cover expenses.

While commercial properties can be lucrative as they carry long-term leases, they are risky in that when they become vacant it is very difficult to find a new tenant in a timely manner. Commercial properties often require tenants to make significant investments in improving the property that may or may not have been utilized for the same purpose.

Many REITs focus on retail properties which have had it very rough in the United States recently. Numerous large retailers have severely decreased their number of stores or ceased operations entirely. As the internet and companies such as Amazon continue to change the retail marketplace, the future of brick and mortar retail stores is in jeopardy.

Why Go With a REIT Instead of Purchasing a “Turnkey” Rental?

Turnkey rental properties became increasingly popular for real estate investors over the last decade. Many investors see the opportunity for significant profits in purchasing rental ready properties (properties that have already been renovated) that could yield immediate cash flow. Short term rentals and popular platforms such as Vacation Rentals by Owner (VRBO) or Airbnb fueled the popularity of these types of properties.

For some, it is a viable possibility. Those who purchase rental homes in locales frequented by vacationers, it allows for utilization of the property for personal use on occasion. But for the serious investor looking to generate wealth, it may not be the best option.

In purchasing a rental property on one’s own, a significant amount of capital is required to finance an investment property. Most lenders require a minimum of 20% down which is not doable for many investors starting out.

With a REIT, one can invest in income-generating properties without the hassle or headache of having to manage the property. Any rental property owner can attest to the frustration of fielding tenant complaints, marketing the units, tending to maintenance issues at all hours of the day, etc. With REITs you have seasoned professionals with a proven track record managing the properties, taking advantage of all opportunities and maximizing profits.

As you look forward to what the new decade will bring, start by increasing your wealth with a diversified portfolio that includes real estate. The historical performance speaks for itself and the success of REITs shows no signs of slowing down. 

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