You don’t have to choose between positive cashflow and capital growth in property

Now that we’re at the stage of the property cycle where capital growth is lower, and it’s likely to remain that way for some time, more investors are asking: “what’s the right investment strategy?”

Recently Gail Kelly, CEO of Westpac, warned that Australia is unlikely to ever again see the type of housing boom that sparked a massive rise in personal wealth in the past decade. 

At around the same time Reserve Bank of Australia governor Glenn Stevens said the RBA was not trying to “engineer a return to a housing price boom” by lowering interest rates.

So what is an investor meant to do? Is it time to consider cashflow-positive properties? 

How property investors make their money

Firstly it’s important to understand property investors make their money in four ways:

1. Capital growth – the increase in value of their properties
2. Rental returns – which provide cashflow
3. Tax benefits – such as depreciation allowances and negative gearing
4. Forced appreciation – this is where an investor “manufactures” capital growth through renovations or development. 

Smart investors benefit from a combination of all of these.

Can I still get capital growth?
Recently AMP Capital reported that since the 1920s, real estate has returned 11.1% p.a. after allowing for capital growth and rents. That’s a pretty impressive long-term track record  

While there is little doubt that average capital growth will be lower for the next few years, there will always be some pockets that outperform the averages. And within those areas there will be some properties that grow strongly in value while others perform poorly. That’s how averages work.

What about positive cashflow?
A positive cashflow property is one where the rental income received covers all of the property’s expenses (including interest), leaving money in your pocket each month. 

In general properties with higher capital growth have lower rental returns. This means you can’t find cashflow-positive properties in the higher growth, better locations of our capital cities. You must look to regional areas or mining towns where buyers require a higher rental yield (cashflow) to make up for the lack of capital growth.

Of course buyers with lower loan-to-value ratios, those who put more money in the deal may also experience positive gearing. The problem is they miss out on the benefit of leverage.