Can you have your cashflow cake and a piece of the capital growth property pie?
Those in the property game who prioritise returns are said to be ‘positive cashflow investors’. Their strategy is to seek out properties that generate enough rental income to cover all holding costs (i.e. Interest repayments, management fees, maintenance, etc.), and essentially provide a positive return.
Often, capital growth is a secondary consideration when employing a positive cash-flow strategy.
Logically, the positive cash-flow investor is generally seeking a percentage rental yield and/or total net income higher than the interest rate percentage payable on their loan.
They can usually achieve this in one of two ways, or by using a combination of both. The first is by acquiring properties that are in stronger rental demand than purchaser demand, thereby achieving higher rents but lower rates of capital growth over the long term.
In this scenario, the percentage rental yield will be comparably higher simply because the value of the property is lower.
In the second instance, the positive cash-flow investor may look at using tax deductions to increase the after-tax income they achieve with their property.
This might entail claiming maximum depreciation benefits, for instance. They can then use their tax return to pay down investment related debt, thereby decreasing holding costs and further increasing their overall income.
Traditionally, properties that provide positive cash flow are often found in ‘secondary areas’, or regional towns and outer suburbs to be specific.
Such locations don’t readily benefit from the same levels of owner-occupier demand that capital cities enjoy, primarily because of smaller populations, lack of diversity in industries, lack of supporting infrastructure and so on.
These markets are often more prone to greater variations, because they’re affected more by general social and economic vagaries, such as a rise in unemployment, unfavourable economic conditions, and so forth.
This is largely because they predominantly attract a lower socio-economic demographic that’s impacted more significantly by things like inflation and a rise in the cost of living.
Furthermore, these areas often have a large amount of developable land, so while demand is generally lower, supply is often higher than across inner city areas. As such, the likelihood of properties in regional areas achieving target capital growth rate is lower.
A high rental yield can also indicate a property investment that has limited capital growth rates. In these circumstances, the ‘market’ commands a higher return (in the form of rental yield) to compensate for the lack of capital growth prospects.
Positive cash-flow investors need to keep in mind that they will be achieving additional income through their property portfolio, which will obviously be subjected to prevailing income tax rates. This is important when adopting the positive cash-flow strategy, and should be considered in your overall financial analysis.
A new kind of positive cashflow
In this continuing low interest rate environment, many established property investors who already have significant equity built up in their property portfolio are finding that their high growth, ‘investment grade’ assets are transitioning to a positive or at the very least, neutral cashflow status.
Factor in an additional market fundamental, being growing tenant demand in these prime investment areas where rental accommodation is tightly held, and you have the perfect positive cashflow storm on your hands.
So is it possible for more investors to have their cashflow cake and eat a chunk of the capital growth pie too? Seemingly, right now anyway, the answer is definitely, maybe.
This is a much more appealing way to achieve a more balanced cashflow position with property as far as I’m concerned.
Investors who actively chase returns over long-term growth are sacrificing much of the benefit to be derived from that essential component of wealth creation – compounding.
As such, you generally need to accumulate a large number of properties to generate an adequate retirement income, which can be costly and time consuming.
A positive cash-flow strategy has its place in property investment and represents less of an income burden for risk adverse investors.
But as with every aspect of your chosen investment vehicle, you need to weigh up all the pros and cons in light of your overall objectives and investment strategy, before determining whether this is an approach you want to actively pursue.
If you would like more information on how you can profit from investing in Australia’s residential real estate sector by establishing clear investment strategies and structures, contact us or subscribe to receive regular post updates and industry insights.
Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: email@example.com
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