PROPERTY SHOWDOWN: CAPITAL GROWTH VS CASH FLOW
Most people want a passive income, and think that cash flow will get them there. The truth is, that cash flow alone won’t cut it. Ultimately, it’s capital growth that sets you free. Cash flow is a tool you use to get there.
You need a balance of balance between capital growth and cash flow properties in your foundation portfolio.
Not yet convinced? Then keep reading!
BUYING FOR CASH FLOW ALONE
There’s a commonly held belief that if a property earns you a bit of cash each week then it must be a good investment. This is not true.
Say, for instance, you purchased a positive cash flow property in a regional area. Each week, rent earned you around $100 cash before tax, giving a yearly taxable income of $5,200. (Don’t forget the government still needs to take their share!).
FAST FORWARD 10 YEARS…
The value of the property hasn’t gone up, in fact, it went down for a while, and back up again, but, apart from that, it is pretty much the same as when you bought it.
During that time, rent went up slightly (keeping in line with inflation) but, your property was vacant, on and off, for around six months.
Then, you also had maintenance and repairs that ate into your weekly cash flow over a couple of financial years.
And, one lot of problem tenants failed to pay the rent for a couple of months.
After all this time you still haven’t paid down debt completely, and your cash flow went from positive to neutral, to negative, back to neutral and then slightly positive, then negative …
That property which gave you such a tingle to start with, has turned into an emotional rollercoaster and a headache!
BUYING FOR CAPITAL GROWTH ALONE
Let’s take the time machine, travel back and decide not to buy that regional property. Let’s buy a metro property instead. It’s a blue chip property with great growth prospects, but is has a negative cash flow. You will need to cover the difference through your salary.
10 YEARS HAVE PASSED…
Great news! The value of the property has doubled since you purchased it. At last, after a long wait, the cash flow has just turned slightly positive.
During the years of waiting, you wanted to buy more properties with your equity, but, your income was so badly affected from holding a negatively geared property, that you couldn’t possibly service another loan.
Even now, you have a lot of equity, but very little cash flow. How can you pay for the lifestyle you want? Answer, you decide to sell the property.
Sadly, after the property is sold and all selling costs, taxes and outstanding debts paid for, you profit is not as high as you had hoped for. Especially after you factor in all the money you spent just to hold onto the place. You may as well have put your money in a savings account!
CREATING NETWORTH AND CASH FLOW
So how can you become financially free of debt, and create a passive income?
If you want to retire early, or just live life on your terms you need to buy the right mix of properties, in the right order.
Buying good capital growth properties can help you improve your net worth position. If you have structured your finance well, you may be able to use equity from capital gains to fund the next deposit.
As each property in your portfolio goes up in value, you may be able to tap into more equity to buy even more properties.
In order to service these loans, however, you need to have a good income. Properties that offer a good cash flow can improve your income prospects in the eyes of the banks.
THE ‘PERFECT’ PROPERTY DOES NOT EXIST
You need to strike the right balance. It’s very rare to find properties which tick both boxes.
So, instead you need to buy the right mix of individual cash flow and capital growth properties to build a good foundation portfolio.
To really strike the right balance, it is essential to purchase in line with your goals and financial position, while also buying each property in the right order.
A property investment expert can help you map out the right strategy to achieve your goals. This should help you know whether to focus on capital growth or cash flow at each stage of the journey.
PAYING DOWN DEBT
Once you have built a portfolio of properties, with an overall neutral cash flow and a good upside for growth, the properties should sustain themselves financially while you do your usual thing.
As loan repayments move into principle plus interest, rents should go up in line with market conditions. If not, at least you have more than just one property to tinker with.
In time, the value of the properties should increase and hopefully even double. Historically this happens on average once per decade. When this happens, you may be able to sell half of your portfolio in order to pay off the rest.
Alternatively, you may be able to use equity to purchase cheap land, build on it, and sell for profit. You could then use your earnings to pay down debt.
Once you have paid off debt in full, you will have the positive cash flow to set you free!
So, what are your thoughts now on cash flow vs equity? Do you still prefer one over the other?