By Steve Waters
More property magazine column inches have probably been devoted to this subject than just about any other – but I think those picking sides in the Cash Flow v Capital Gains debate are missing the point.
Investment strategy 101
The theory behind the argument of whether to invest for either cash flow or capital gains, stems from the simplistic reasoning that investors can only have one or the other, but not both.
As a gross generalisation, if properties are located close to CBDs in blue-chip positions, then capital gains are sure to follow, but the relative rental return won’t be so hot.
Similarly, other investors seeking high rental returns from their ventures don’t expect the values to shoot up quickly, because high yield properties are often in fringe locations with less scarcity and more generic housing on offer.
Where it all falls apart
In essence, the main error in choosing a strategy is it fails to recognise that smart investors take a holistic approach to their multi-property portfolios – and healthy portfolios are balanced.
That way, depending on the investor’s requirements at a given point in time, the portfolio can be weighted slightly towards cash flow or capital gain.
Real estate accumulation shouldn’t be built on a ‘one strategy’ approach, but rather should comprise a mix of property types that will service the investor’s immediate needs with a long-term perspective on wealth building.
Each and every purchase needs to be deliberate and have a desired outcome that makes sense to the overall balance sheet.
This is why multi-property portfolio’s make sound financial sense.
ABS data shows around 8% of Australians own an investment property.
That’s approximately 1.9 million people.
The problem is that most – around 85% – of those investors only own one investment.
And the percentage drops dramatically as you increase the number of holdings.
Did you realise only around 0.07% of Australia’s population own 6 or more investment properties?
That’s just under 17,000 Australians with a multi-property portfolio set for a healthy retirement.
When to hunt for cash flow
I realise the definition of ‘high rental returns’ can be different measures in different markets and during different time periods. An investor in metro Melbourne would be ecstatic with a 5% gross yield while someone buying in regional Victoria would scoff at the idea of so little.
That said, the upside in buying a cash flow investment is that it provides sustainability to your portfolio by mitigating risk.
A high cash flow where all the income takes care of all the expenditure gives you serviceability, which gives you time in the market because you’re not at the mercy of high interest rate and market fluctuations. You have enough dough to take care of the bills.
The negative is you don’t get the same growth in dollar values as you do when you buy a capital gains oriented property.
Most would agree you don’t get truly wealthy from cash flow alone.
Why you need capital gains
Capital gains help make the big money, because in a sustainable market, if you’re holding $2 million in assets, an annual rise of 5% in value translates into $100,000 in the first year which continues to compound as the property price cycle runs its course.
The downside to being heavily exposed to capital gains investments is there’s not as much risk mitigation, because you don’t have a high-income buffer to help in the down periods.
Your susceptible to external risks such as interest rate movements, unexpected unemployment or vacancy rates.
You’re backing an odds-on favourite every time and sooner or later it’s bound to get beaten.
What’s the answer?
Constant vigilance is the key.
Don’t let anyone tell you property investment is a set-and-forget proposition because successful investors ensure their portfolio is consistently and periodically reviewed so their next purchase will be perfect for their requirements.
You need to understand the maximum shortfall you can tolerate out of your disposable income to support the whole portfolio and that should be your trigger to change tac or stop investing before you start getting into the red.
The best investments find a balance of both CF and CG where you can earn a decent cash flow in the short term, while realising a healthy capital gain in the long haul.