Positive Cash Flow or Capital Gain?
There’s been an ongoing debate in property investing circles about whether you should invest in positive cash flow properties (those where the rent is more than your mortgage) or capital gain ones (those where the rent doesn’t cover the mortgage, but tend to rise more in value). Let’s examine objectively which option would suit investors best.
Positive cash flow properties are generally found more in regional areas, slightly further away from major cities, and which might have rents in the region of 5-10% of the property’s value. A classic example is a mining town, where people will seek a rental for one to two years (the duration of their employment in that town).
The argument for positive cash flow properties is that there is no limit to how many you can accumulate, as they put money into your pocket each week. If you’re on a lower income or don’t want to have to use your limited wages to top up your property portfolio, then these might be the best option for you. Buying further away from cities affords you larger properties – that is, a house rather than a unit. And they do say that land appreciates while buildings depreciate – so the more land you have the better.
The main disadvantage about these positive cash flow properties is that often they don’t grow as much as ones that are closer to the cities. They might grow at 5% instead of 10%. If they don’t grow in value as much, it can be very hard to create enough equity to help fund the deposit on your next investment property – and that’s your limiting factor slowing your wealth creation down.
Capital gain properties are typically found 5–15kms from major CBDs. The attraction to them is that they might grow at around 10% per year, because land is in short supply within these areas while there’s plenty of demand due from buyers who only want to commute a short distance to the city. As they do tend to grow quickly, it’s simple to use the increased equity as a deposit on your next investment, increasing your portfolio of properties much quicker.
The main disadvantage of capital gain properties is that the rent doesn’t cover the mortgage and so you’ll need to top it up. If a typical $500k property (with a 5% rent) loses you $10 – 20k in cash flow per year (depending on your tax), you really need to have a high income or a lot of equity to fund the difference. Think of it as saving $1-2k per month to make $50k at the end of the year.
The ultimate property is the one that has a bit of both, but they are often scarce or near on impossible to find. Some investors start with positive cash flow and then move towards capital gain properties as their portfolio and income grows. Others tend to have a mixture of both. The danger for real estate agents and investors is that it’s easier to invest on your doorstep, but it may not give you what you are after.
To build the ultimate portfolio, you need to do your numbers and let that dictate where and what to buy.