Most property investors starting out on their journey will ask themselves, “What is my goal, positive cash-flow or capital growth?”. It’s an important consideration now more than ever, as COVID-19 has so many people spooked, and because we all have unique circumstances, there is no universal right or wrong answer to this question.
Positive cash-flow is favoured by many property investors for a multitude of reasons:
- A positive cash-flow property allows you to, ‘get into the game’ and afford the property on a day-to-day basis.
- In an increasingly difficult lending environment, higher yielding properties can really help get finance over the line.
Note that most lenders only recognise a percentage of the actual rent received and disregard many property tax deductions. As a result, they don’t recognise positive cash-flow or negative gearing benefits in the same way as the Australian Taxation Office.
- Peace of mind. Even if the value of the property drops after purchase, positive cash-flow should still be maintained, providing the market has strong fundamentals and is not reliant on one industry sector (e.g. mining or tourism).
Most people invest in property to provide income for retirement, so many would think that positive cash-flow should be at the top of everyone’s wish list. The reality is that when we speak of positive cash-flow, initially we’re normally only talking about a few dollars per week.
This positive cash-flow will keep us in the game, but it’s unlikely to be enough for a comfortable lifestyle.
We’d like to state for the record that there is no magic formula to accurately predict capital growth.
There are, however, some major indicators that we feel you should pay attention to so that you have the best possible chance to achieve capital growth. Here are a few:
So why do people chase capital growth instead of positive cash-flow?
Well, in the early stage of your property investment journey, you will need capital growth to provide equity to leverage into your next property. This can provide the ‘springboard’ for your ongoing acquisitions.
Without this equity growth, it’s unlikely that you will be able to save for your next deposit quickly enough. And it’s extremely unlikely that a positive cash-flow property will accelerate your savings capacity in any significant way.
Capital growth is also a critical element of a popular exit strategy, namely to sell some properties and pay off residual debt to achieve a passive income.
Here’s a very basic example:
Value of Investment Property Portfolio 2020 $3M
Debt on Investment Property Portfolio 2020 $2.6M
Value of Investment Property Portfolio 2030 $6M
If you sold property to pay down outstanding debt in 2030, you could have an unencumbered investment property portfolio valued at approximately $3.4M.
At 4% rental yield, this would result in a gross annual rental income of about $136K. This figure would provide a very comfortable retirement for most Australian couples.
These are very rough calculations and the gradual sale of investment properties in low (or no) income years could be recommended to minimise capital gains tax.
The potential trade-off with capital growth property investment strategies is that you need to bear the holding costs (negative cash-flow) of your properties. This can be too much of a burden for many investors while waiting for rents to go up.
Is there another way? Can you get capital growth AND positive cash-flow? This outcome is sometimes referred to as the, ‘holy grail’ of property investment.
It’s not always easy, but the good news is that it is possible.
For example, a well-located capital city property that has enough land component for a second dwelling (e.g. a garden apartment) can achieve positive cash-flow and still retain its capital growth potential. This is a popular strategy with Adviseable clients.
And let’s not forget that some major emerging regional areas have superior rental yields as well as capital growth potential.
So, going back to our original question, the potential trade-off between positive cash-flow and capital growth needs to be carefully considered. Your investment timeline can be an important factor, as well as the scale to which you want to invest.
Also, keep in mind that younger investors generally have more time for a capital growth based strategy, whereas investors nearing the end of their work-life may have more of a focus on creating positive cash-flow to contribute to living costs.
The reality is that if you’re aiming for meaningful wealth, you will probably have a mixture of positive cash-flow and capital growth properties in your multi-property portfolio, and dependant on your particular circumstances including your risk-profile, and the stage you are at in your Property Investment career.