Cash Flow vs Capital Growth vs Compound Growth: What’s Best for You?

Expert Advice with Cam McLellan 27/10/2017

There’s no ‘get rich quick’ scheme to build your wealth, but three types of investment strategies tend to drive people’s property investment portfolios: cash flow, capital growth, and compound growth.

These three strategies are the fundamentals that underpin your property investment strategy, and yet many people swear by just one or the other.

In this post, we provide an overview of each type and analyse which strategy best serves the purpose of building wealth for the long term.

Breaking down the three key property investment strategies

Capital Growth Strategy

Capital growth is where a property investment increases in value over time. It’s calculated based on the property’s current value compared to the amount invested in it originally.

For example, you might achieve capital growth if you renovate or extend a home. But that’s not going to get you much in the long run – better to buy a property in a suburb that then skyrockets in property growth value thanks to short supply and strong demand.

Capital growth is a great way to achieve wealth if you’re doubling your asset holdings every 7-10 years.
Take a $400,000 portfolio. With capital growth doubling every decade or less, that initial investment is going to shoot up to anywhere between $3.2 million and $6.4 million in 30 years.

Pros
•    You’re more likely to record a loss in the beginning, but the tax benefits of negative gearing will take care of that.
•    You could get a better LVR, with banks happier lending to properties in high growth areas.
•    The long-term increase in value outweighs short-term cash flow benefits.

Cons
•    With low or even negative cash flow, you might need to use your own resources to cover property-related expenses.

Cash Flow Strategy

Cash flow is the amount of money from rent that you can shove into your back pocket after you’ve taken out those ongoing property costs. The equation goes:

Gross rental income – property expenses – loan repayments + tax benefits = cash flow

Keep in mind cash flow isn’t always positive! Many Australian suburbs are seeing a faster rise in property prices comparative to rent so you could produce negative cash flow. That is, your loan repayments are higher than your property’s cash flow.

Those with a cash flow property strategy are tempted by its simplicity and short-term benefits. You invest in properties with a high rental yield that covers the total expenses of holding the asset to generate an ongoing income.

For example, many people aim to live off their property income by investing in properties that deliver strong rental yields. The idea is you can then use your positive cash flow to build your portfolio. Once you reach your desired passive cash flow, you can live off your property income entirely.

Pros
•    You’ll get a weekly income that helps you realise your investment short-term.
•    You can use the rental income to cover property expenses.

Cons
•    Properties with high rental yields generally have little to no capital growth.
•    With a positive income, you can’t make the most of the negative gearing benefits – in fact, you could end up having to pay tax!

Compound Growth Strategy

Compounding in property investment is where you reinvest the equity from one property into another property – basically, using your earnings from one asset to generate more earnings.

Compound growth is calculated as the average rate of growth you’ll experience over a period of years. It’s not a linear type of growth. Your compound growth rate could start off sluggish, but after a while, it’ll gain momentum. The more properties you have, the faster your growth compounds.

The key factor in compound growth is time – the longer you have to grow your portfolio, the faster your compound growth accelerates. So you really do have to start early if you want to get the most out of it.

Pros
•    You’re using your assets to generate growth upon growth upon growth.
•    If you start early enough, you could see substantial wealth in the long-term.
•    The long-term increase in value outweighs short-term cash flow benefits.

Cons
•    This isn’t a quick way to get rich – it will take time.
•    In the beginning, you may need to cover property expenses out of pocket.

Capital Growth is where the real wealth is!

If you’re in it to build wealth for the long term, there’s no sense in focusing on a cash flow strategy – you’re just not going to build the same level of wealth.

But the best strategy is to find a property that helps you achieve all three tiers of property investment – that is, a property that guarantees capital growth with a high rental yield, and where you can use the equity to reinvest in another property with the same advantages.

The problem with cash flow properties is that they’re usually regional or on the city fringe, where the properties are unlikely to double in value nearly as often as a capital growth portfolio.

Take the example of a capital growth strategy I mentioned above, where you could be making up to $6.4 mil in 30 years. The same investment of $400,000 in a cash flow portfolio could only bring in $1.6 million after 30 years, if the property doubled every 15 years.

Many people see the potential negative cash flow in a property investment as a downside to a capital growth strategy and shy away from it – they fail to look long-term, to how your property will be sitting in a decade if you make a clever investment.

But if you crunch the numbers, the results are clear: while investments with positive cash flow can generate good passive income, capital growth and compound growth investments are the only ones that will help you achieve real wealth in the long term.

Your path to wealth creation is going to be entirely unique to your circumstances, with many factors contributing to your success.

But it’s important to understand that wealth creation isn’t a “get rich quick” fix. It’s a slow, ongoing process. If you can find a way to combine the three property investment strategies above, you’ve hit the jackpot.

But there is a hierarchy to what works best. Put capital growth above all others and you’ll find yourself on the path to long-term wealth creation.

OpenCorp can help you develop the best property investment portfolio and find the right properties for your needs. Learn more about getting property investing with OpenCorp today!

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Director of OpenCorp, Cam McLellan is committed to sharing his passion and property investment knowledge with everyday Australians.
Cam started investing in real estate at a young age and quickly mastered the art of building sustainable wealth. He has used the same wealth building strategy to develop a multi-million dollar business, sharing his knowledge and skill with ordinary Australians. Cam has personally bought, sold and developed numerous properties and has an extensive residential and commercial investment portfolio.

Read more Expert Advice from Cam here!

Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.

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