Capital Growth or Cashflow: Which is King?

by Greg on June 25, 2015

The King

It is one of the quintessential questions when it comes to real estate investment, and one that has sparked debate amongst experts and advisers over the years: that is, which is better, capital growth or cash flow?

Determining which strategy is best suited to your own individual needs requires assessment of a range of factors. There are many elements to consider, and often would-be investors get caught up in details of the wrong sort: the finishes of the property, and whether it suits their personal aesthetics. The details that savvy investors focus on are the hard facts that make an investment sink-or-swim – they’re considering whether capital growth or cashflow is more important when it comes to their property investment. In today’s brief, we weigh up the relative value of both elements in a successful investment plan.

Capital Growth is Capital!

Those in favour of capital growth argue that it provides a direct strategy to build your ‘nest-egg’ because it allows an individual’s personal net wealth to increase in line with the property’s value growth.

Capital Growth has Taxation Benefits

The other major draw cards are the benefits associated with Australia’s tax system which helps pay for the investment through negative gearing concessions. Hence, the long-term capital growth approach has some incentives built into its strategy, as the losses incurred can be offset through various taxation benefits. Also worth considering is that these negatively geared properties are generally more expensive to purchase than properties which are cash-flow positive – and tend to be located in and around capital cities or major regional centres where there is strong demand from buyers.

Hence, if you’re looking for a quick return on your investment or have concerns surrounding your immediate cash-flow position, the long-term capital growth approach may not be a suitable strategy for you to run with.

Capital Growth is a Long-Term Strategy

Also worth bearing in mind is that capital growth is a long-term investment strategy, typically in the range of seven to ten years. Likewise, this strategy typically aims for an annual increase in value of anywhere between 7-10 per cent within that period. Yields however may be around the 5 percent mark.

Understand Your Own Personal Financial Position

However, it’s important to acknowledge that capital growth means different things to different people – what represents excellent growth to one investor may be totally unsuitable to another. The trope of your investment expectations will be determined by your life stage and financial position. If you are in your twenties and looking to make your first investment, time is on your side. You may be prepared to forego short-term capital growth in exchange for manageable investment cashflow and getting your foot on the ladder of ownership, looking at the long-game and natural increase in property value that comes with it. If you are close to retirement and hoping to capitalise on your investment dollar, you may seek property which offers swift capital growth. This usually means investing a larger amount of ready funds into property in premium locations – and often, stretching your finances in the short-term in exchange for blue-chip capital growth. In both cases, you can’t hope to achieve long-term or short-term capital growth without taking into account your cashflow position.

Yes, Your Majesty

Those who pursue this strategy find comfort in the fact that their properties will return enough profit to cover the costs involved with purchasing the investment property. For this reason, the cash flow strategy tends to appeal to younger or first time investors with less disposable income to play with. These investors are also typically looking for a lower-risk profile strategy as comparable with those properties purchased by longer-term capital growth investors with higher price points.

The Trade Off Between Cash-flow and Capital Growth

As a general guide, experts believe properties bought for rental yields are expected to achieve around six to ten percent a year with capital growth of around four to six percent. There are cases where some properties will enjoy both strong rental yields and healthy capital growth, such as the case in regional or small towns in remote areas that experience strong growth as a result of say a mining or tourist boom. However, these cases can be few and far between, and tend to be the exception as opposed to the rule.

The disadvantage with cash flow positive properties is that investors must pay tax on the income produced from the property, effectively reducing the overall return or yield when all things are considered. On the other hand, negatively geared properties have the ability to enjoy tax benefits, especially for high income earners.

Understand Your Cash-flow Position

Without quality, well-managed cash-flow, you can’t hold any investment property – let alone wonder over your capital growth. Establishing appropriate cashflow is profoundly personal, and there’s no ‘one size fits all’ formula to the right investment for you. If you have a limited budget, you can still become an investor – you’ll just need to uncover a property whose rent covers its mortgage so that your cashflow is not negatively affected. Should you be in a flush financial position, you may be to subsidise the purchase of a more expensive investment property by contributing to the monthly mortgage payment in addition to rental income. Critically, you should never be overstretched by poor cashflow management. Overcommitting and restricting your lifestyle and cashflow can result in having to sell an investment property before having reaped any benefit – so be conservative in the first instance!

Conclusion

Ultimately, selecting the right strategy to implement when investing in property depends on the individual’s personal and specific needs, and perhaps most importantly, financial disposition.

If you’re concerned with cash flow implications and have less disposable income to work with, then finding a property with a healthy rental return is clearly going to be the favourable position to adopt.

If however, you have more reserves to play with and are looking for a longer-term buy and hold strategy that can deliver larger capital growth over the investment period, than adopting the capital growth approach will definitely be the one for you.

With all this being said, however, it’s important to recognize that what works for one person may not work for another. It is strongly advised that anyone endeavouring to enter the property market should consult with an investment specialist to help you plan the most suitable strategy for your specific needs.

 

Phil Hartog

Phil Hartog is a property investment consultant who works for IPRG. He has been involved with building and construction for many years, and enjoys assisting clients with real estate finance and investment advice on a day-to-day basis. In his spare time, Phil enjoys writing short stories and also writes articles for his IPRG’s blog

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