Buy for cash flow or capital growth?
Most property investors, when they start, are focused on cash and cashflow. There seems to be an obsession in the market with positively geared properties, high yields and investors tend to forget about the reason why holding an asset is so important for wealth creation.
Let’s break down the strategies and see if you get my point.
Cash Flow Properties
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 a loss.
In order to find such properties you must go to regional towns, mining areas, multi student accommodation (etc etc) making the investment high risk as you only rely on one type of tenant.
Due to multiple factors, these types of properties tend to have lower capital growth rates but are great cash flow generators for investors. This is also called “positive gearing investing”.
Capital Growth Properties
This strategy is based on purchasing properties that will probably have above average capital growth over the long term. They are generally more expensive and located in well known and established areas with a proven history. These are usually areas where the market is really tight and it’s rare for a property to become available in the market.
In these areas there is a big owner occupier appeal, there might be a reputable school, club or even closer to the beach or with an ocean view; The rental yield therefore is not enough to cover for the property expenses making this type of investment a “negatively geared property”.
A lot of the suburbs where these properties can be found are called Blue Chip suburbs and just like the stock market, this term is used because it’s a property that no matter what, will always return a minimum amount in growth that outperform the market;
Conclusion
I have a firm belief that a 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.
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).
Diversification is the key and in a portfolio there is always space for both strategies to take place in order to achieve a bigger goal.
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 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, these are also known as “neutral geared properties”.
Real wealth and success in property investment is not derived from income but through long term appreciation (capital growth) and the ability to leverage off each asset to buy further assets, providing you have the financial capacity (cash flow) to do so.
This is why it is so important to have the right strategy in place and the correct professionals to guide you through it.
