Cash flow versus capital growth
Investors often have to choose between cash flow-positive properties and those that will deliver market-leading capital growth – but if you want to build up substantial wealth, there's one thing you need to know.
Blogger: Cam McLellan, director, OpenCorp
When it comes to investment strategies, there are those who use a cash flow strategy and those who understand that real wealth is only achieved by using a capital growth property strategy. The aim of a cash flow strategy is to supplement your income and retire at the end point. But that doesn’t mean you will retire earlier than you would using a growth strategy. That will depend on your initial available capital and the timing of the next market growth cycle.
A cash flow strategy is very simple. Identify properties with a rental yield higher than the total amount of your expenses, interest repayments and holding costs. Once your desired level of passive cash flow has been reached, you have a choice about whether or not you want to remain in the workforce.
There are a number of problems with a cash flow strategy. The first is the amount of capital required in today’s Australian markets to establish a sufficient cash flow positive portfolio. This aside, the main issue when considering a strategy to build wealth is that real wealth comes from doubling your asset holdings every seven to 10 years. You will never achieve real wealth by trying to supplement your income. I’m sure you’ve realised by now that I’m a capital growth property strategist.
The properties required to build a cash flow portfolio are usually located regionally or on the outskirts of major cities. With regional properties you’re lucky if they double in value every 15 years, so we don’t consider them as part of a capital growth strategy.
Here’s an example of how a growth strategy outperforms a cash flow strategy.
If you were to invest $400,000 into a cash flow property portfolio and assume that it would double every 15 years, then your initial investment will double twice in value over 30 years. Its value at this time would be $1,600,000. This may seem like a large amount in today’s money, but in 30 years it won’t buy you much.
If you made the same $400,000 investment in a growth property portfolio and assume your investment will double every seven to 10 years, then you can assume your initial investment will double three to four times in 30 years, which means if doubled every 10 years it will be worth $3,200,000. If it doubles every seven years, the end value will be about $6,400,000.
Be very clear on your desired end position when comparing and considering these two strategies. You can’t save your way to wealth with rental income or earned income.
I also want to make it clear that you should never combine these two strategies when building your portfolio. Decide on your preferred strategy and stick with it. If you’ve already started on a cash flow strategy path and you want to switch to a growth plan, I recommend you sell up and realign your portfolio to your plan.
Tips
• You can’t achieve real wealth by trying to supplement your income
• Regional properties generally double every 15 years and are not suitable for a capital growth strategy.
• Growth properties historically double every seven to 10 years
• Never combine these two strategies when building your portfolio
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Overcoming analysis paralysis to achieve investment results
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Does your accountant understand property investment?
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Is your investment property underperforming? What To Do
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How to consolidate your debt as a property investor
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Investment terms explained
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Are 'rentvestors' creating more wealth than owner-occupiers?
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Overcoming setbacks in your property investment journey