Check out this short article for property investors and owners on cash flow vs. capital growth and how to build long term wealth.
Property investors can increase their wealth in four ways:
1. Capital growth – an increase in value of a property
2. Rental yield – positive cash flow generated from tenants paying rent
3. Tax benefits – allowance for deductions such as depreciation, loan interest, the cost of maintenance, etc.
4. Forced appreciation – capital growth that is created by renovating, developing, or otherwise improving the property.
A savvy investor can benefit from a combination of all four strategies, and ideally, it’s best to let your chosen strategy dictate the selection of properties, rather than choosing a property that will force you into one strategy or the other.
Which strategy is better – capital growth or cash flow?
Unfortunately, there’s no straight-forward answer to this question. Each strategy has it’s benefits, and some properties are geared more toward one or the other, but both will depend on the property’s location and condition. The strategy you choose will almost certainly be determined by risk.
Capital Growth Generally, a property with a higher potential for capital growth will have lower rental returns. If you purchase a property in a good location for less than market value, then develop or remodel it, you stand to see a significant growth in capital. These properties are considered to be less risky but usually won’t offer much in the way of regular income.
Cash Flow An income property is one where the rental return is high enough that it covers all of the property’s expenses, such as maintenance and interest, leaving you with extra cash to stash away each month. Many beginning investors start out with cash flow properties to generate income immediately. However, if the high rental yield is the result of a cheaper building in a less desirable area, this implies more risk.
Building Long-Term Wealth A purely cash flow property will allow you to rely on monthly income, but because this will function much like a salary and may prevent you from building long term wealth. If you are looking for a property that will generate rental return, it would be wise to choose one that also has a potential to appreciate in value. Considering your longer-term strategy, take into account the increased costs of maintenance and redevelopment. If interest rates increase as they are expected to, a property that is cash flow positive today could become cash flow negative in the future. Those investors who prioritize capital growth over cash flow will benefit from much higher returns in the end, and enjoy larger tax benefits if they sell the property 10 years down the road. When investing in real estate, evaluating risk should be supplemented by an understanding of the market and the area, which involves making informed cycle predictions. When buying, managing, and selling property, it is always a good idea to have an experienced broker and/or property manager in your corner.
Written by Sara Thompson on Tuesday, 24 June 2014 12:22 pm