Question: I’m trying to understand the cash flow versus capital growth argument. Is one investment strategy considered better than the other? I’m a single, high-income investor based in Canberra – is one strategy better suited to me than the other?
Answer: When it comes to property investment, you’ll often hear two somewhat conflicting philosophies being bandied around. Firstly, there are the ‘cash flow’ followers: they suggest you should invest in property that has the capacity to generate high rental returns in an attempt to achieve positive cash flow. In other words, you want rental returns that are higher than your outgoings (including mortgage payments), leaving money in your pocket each month.
Then there’s the ‘capital growth’ crew. Their favoured strategy is to invest for capital growth over cash flow. In other words, you need to buy property that produces above-average increases in value over the long term.
In Australia, properties with higher capital growth usually have lower rental returns. In many regional centres and secondary locations, you could achieve a high rental return on your investment property but, in general, you would get poor long-term capital growth.
Clearly, if both exist, there is a place for both; so to answer your specific question appropriately, I really need to know what you want to achieve. You see… property investment should be part of a wealth creation strategy, not just a purchase in isolation.
Having said that, there’s no doubt in my mind that if I had to choose between cash flow and capital growth, I would invest for capital growth every time.
You say you have a high paying job, so I assume you are considering property investment to build an asset base to one day replace your personal exertion income. This means your aim is to grow a large asset base and then enjoy the cash flow your ‘cash machine’ churns out.
The few dollars a week your positive cash flow properties might bring in, is not really going to make much difference to your lifestyle or your ability to acquire and service other, more desirable properties for your portfolio, is it? You can’t save your way to wealth – especially on the measly after-tax positive cash flow you can get in today’s property market. And in a rising interest rate environment as we are experiencing, a property that is cash flow positive today may be cash flow negative tomorrow.
It’s important to understand that wealth from real estate is not derived from income, because residential properties are not high-yielding investments. Real wealth is achieved through long-term capital appreciation and the ability to refinance to buy further properties. If you seek a short term fix with cash flow positive properties, you’ll struggle to grow a future cash machine from your property investments – it’s just that simple.
But here’s the trick...
You can’t turn a cash flow positive property into a high growth property because of its geographical location. But you can achieve both high returns (cash flow) and capital growth by renovating or developing your high growth properties. This will bring you a higher rent and extra depreciation allowances, which converts high growth, relatively low cash flow properties into high growth, strong cash flow properties. This means you can get the best of both worlds.
- Answer provided by Michael Yardney, Metropole Property Investment Strategists. (www.metropole.com.au)