Should you buy for Cash Flow or Capital Growth?


Buying purely for cash flow
This strategy is based on purchasing properties that have very high yields. The rent or income received from these properties not only covers all of the interest, maintenance and other costs associated with holding or owning the investment property, but there is also money left over.  This means that the investor has no out of pocket expenses and those that recommend this strategy will suggest that you only buy property with high rental returns so that owning an investment property does not cost you anything.  In most cases, to find a property where the rental income earned covers all the interest and costs associated with owning the property, you would have to buy low value properties in small regional towns or, high risk properties like student accommodation. These property types will generally have slower and lower capital growth trends; however they provide excess cash flow to the investor. This type of investing is sometimes called positive gearing. An example of a property that would fit into this category would be a house in the country town I grew up in, Narrandera NSW, with a purchase value of say $230,000 and an expected rental return of $280 per week. Based on these numbers the rent would cover all costs and the investor would have money left over.

Buying purely for capital growth
This strategy is based on purchasing properties that will probably have above average capital growth over the long term. They are generally expensive and located in “sexy” (as in it sounds great to tell your friends you own a property in that suburb!), well known and established areas with a proven history. The rental yield or return on these properties is in most cases is very low (in comparison to the price paid to acquire them).This strategy is also called  “negative gearing”, meaning that the expenses associated with having the investment property (loan interest, maintenance, rates) far exceed the rental income derived from it which makes it difficult for the everyday investor to accumulate more than one or two of these types of properties in a lifetime. Buying property for capital growth only will mean that they are very heavily negatively geared. An example of a property that would fit into this category would be a 3 bedroom home in Balwyn, with a purchase value of say $1,200,000 and an expected rental return of around $800 per week. The costs are much higher than the rent received and therefore this property would cost the investor $300+ per week to hold on to (imagine when interest rates go up by 1%!)

If you were only ever going to buy one property in your life, you would buy for capital growth – no doubt about it. A property growing at a conservative 6% per annum will always out perform a property with positive cash flow of say $50 per week or $2,500 per annum (I am going to really crunch some numbers on this in my next article so keep an eye out).

However, successful property investment should be part of a wealth creation strategy – not just purchasing one property in isolation. To create financial independence for your future, the key is to accumulate multiple properties before retirement. When you retire, the rental income generated from each property becomes your ongoing disposable income (it’s a bit more complex than that but you get the picture!).

A cash flow positive property simply won’t provide the capital growth needed to acquire further properties (or it will do so at a much slower rate), and a capital growth property will mean you simply won’t be able to afford to add to your portfolio again as quickly as you would like (because of the high holding costs).

Buying for both
I’m a big believer in diversification, and there is a time and a place for both of the above strategies. When an investor is heavily negatively geared after three or four properties it may be appropriate to look at cash flow positive properties to balance the portfolio. And likewise when an investor is heavily positively geared, capital growth properties may be the solution as they can use their existing surplus cash flow to fund the negative cash flow on a new property.

The key however, to expediting the expansion of your portfolio is to buy for both cash flow and capital growth, especially when you are in the early stages of property investing (up to three properties). Real wealth and success in property investment is not derived from income but through long term appreciation and the ability to leverage off each asset to buy further assets, providing you have the financial capacity (cash flow) to do so.

The right property, purchased in the right location using the correct due diligence process will only be minimally negatively geared after tax deductions and will have all the attributes to ensure future capital gain too.

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