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Capital Growth vs. Cash Flow: Why You Don’t Have To Choose - May 2022

By Rich Harvey, CEO & Founder, propertybuyer.com.au

 

There are some well-versed truisms applied to property investing in this country.

“Location! Location! Location!” is arguably the best known, but even “Worst house, best street” is understood by most Aussies.

But another that’s often rolled is, “You can have cashflow or capital growth… but not both.”

I understand the fundamental argument, but I don’t entirely agree with the sentiment. The idea there needs to be a trade-off between return and value growth is a bit of a furphy.

Here’s why I believe you can build a portfolio of excellent growth assets with plenty of income generation.

 

Cashflow vs. Capital Growth

Let’s first cover off on the fundamentals here.

Property investments generate a return for their landlords in two ways – through rental return and property value.

Cashflow refers to the rental income generated by your property. It’s normally expressed as ‘yield’ which is essentially the percentage you earn in rental income per year for every dollar of the property’s value or purchase price.

For example, if you buy an investment for $600,000 and the tenant pays you $500 per week (i.e., $26,000 per year) in rent, that equates to an annual gross yield of 4.3 per cent.

Capital gain refers to the increase in your property’s value. So, if your investment was worth $600,000 at the start of the year and $660,000 at the end of the year, your annual capital gain is $60,000, or 10% of the original value.

The argument goes that the higher your property’s capital gain potential is, the lower its gross yield will be, and vice versa.

The reasoning says the fundamentals which drive capital growth – blue chip location, strong buyer appeal, unique elements such as capital city location or waterfront position – are not necessarily the best for generating above average cashflow. Homebuyers in particular will prioritise capital growth drivers and pay a premium for them.

On the other hand, cashflow generating properties are those with strong tenant appeal. They could be in regional centers undergoing a boom in local industry. They could be of a layout that maximises the number of residents who can rent rooms in the home. They might by in a student share house suburb. All great ways to boost your rent, but not necessarily the factors which appeal too owner occupiers willing to pay a little extra.

 

How to have both

As I said, buyers make trade-offs between these two elements all the time during their purchasing decisions, but I don’t think you have to for several reason.

 

  1. Bespoke asset selection is key

If you’re looking to invest in a property, you want an asset that balances both income and capital growth in a way that suits your personal situation.

Much of this will be determined by your financial arrangements. In most circumstances your investment property needs to generate adequate rental income to service your loan and cover most of its operating costs.

By the same measure, you generate most of your wealth through capital gains.

My position is that you can seek a balance in the market. It’s no good overextending yourself to buy an expensive blue-chip home hoping for huge upside value potential, only to then have to then sell it prematurely because you can’t afford the loan repayments.

The solution is to seek advice from an industry expert such as a buyers’ agent. We can source properties that will fit your needs and help you rest easy on the cashflow front.

 

  1. Pay the right price

Another property investment truism is, “You make your money when you buy, not when you sell.”

This means if you pay the right price in the first place, the returns it delivers will fall into place.

If you overpay for a property you will lose on both fronts. The property is always trying to catch up in value to what you outlaid for it. In addition, because yield is calculated by rental return over purchase price, a high buy-in figure results in a low gross yield.

Overpaying simply decimates your wealth-building intentions right from the get-go.

This is where a skilled negotiator like a buyers’ agent comes to the fore. We can ensure you make the least possible concession in price and terms, so your investment starts working for you from the moment you take possession.

 

  1. Wait long term

The way to get both capital gains and high cashflow is to adopt a long-term ownership approach to your investing.

Time in the market delivers on two fronts. If you have purchased an appropriate asset in a good location, rents should progressively rise as time passes.

Secondly, homes with the right growth fundamentals are historically proven to rise in value over seven-to-10-year price cycles.

Within the space of a few years, you will find it becoming easier and easier to service your loans as the rent increases. Meanwhile, compound growth improves the value exponentially, building equity toward your next purchase.

Key, again, is buying well in the first instances.

 

  1. Seek properties with potential

Another way to quickly boost capital gain and rental income is to seek property with potential.

For example, a small renovation project could improve both rent and value. Buying a home in a great location with good bones is a path to immediate gains.

Properties with long-term development potential are great at making capital gains for the patient owner as well. Perhaps the asset you buy could be subdivided or reconfigured down the track due to its zoning or size and dimensions.

These advantageous long-range aspects can be identified by your buyers’ agent.

 

So why offset one element of return for another? Instead talk to a buyers’ agent and find out what can be achieved. You might be surprised to learn that the most lucrative investments don’t require compromise, but instead marry the best of both worlds.

 

 

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