Most investors appreciate that there are two components to the returns from investing in property: capital growth – where the value of the property increases over time; and cash flow – from rental income. An investor’s age, earning capacity and asset base will determine whether they are more interested in long-term capital growth or cash flow returns.
Younger, high-income earners may choose to invest for long-term capital gain. They are not concerned if their net cash flow is less than the costs associated with holding the property. In fact, they often seek investments with such a shortfall because they can claim this loss against other taxable income. In essence, that’s what ‘negative gearing’ is all about.
Other investors, may tend to choose property that delivers a net positive cash flow. These are ‘income’ investors.
Opinions differ as to which is the best approach – to invest for growth or cash flow? In the end overall returns from property will be a combination of both.
Property is a long-term investment
It’s important to remember that property is a medium to long-term investment. The yields will change (as a percentage) over the life of the investment. A property that is cash flow negative when you buy it may well become positive as rents increase and your loan gets paid off (providing you choose a principal and interest loan – which not all investors do).
Where to look for growth
Most new capital city properties will not return a positive cash flow when you first purchase them. This is because rental yields are quite low in terms of a percentage of the purchase price of your investment. Countering this, depreciation allowances on newer buildings are higher and as we noted earlier investors in a high tax bracket can claim investment losses against other taxable income. Well located, quality real estate in capital cities will usually (all things being equal) attract good tenants and enjoy low vacancy rates, so the cash flows will still be consistent and continuous, while you wait for that capital growth to kick in.
Where to find income
In outer suburban and regional areas, it’s possible to locate lower-priced property with comparatively high rental yields and this is a strategy that many ‘income’ investors choose. Regional areas have not historically enjoyed the same capital growth as capital city properties. It’s not wise to generalise, as the regions are so vast and their economies and growth drivers are very different. Mining towns are regional and many investors have enjoyed stellar short-term growth and unbelievable rental returns in these areas, but they may be regarded as high risk.
– Philippe Brach