When it comes to buying an investment property, you may literally be putting your ‘life savings’ on the table. It is important to tread carefully, and starting out right can be fruitful enough to lead you to build a portfolio of two, three, or more investment properties.
When deciding to buy an investment property, the choice of either capital growth or cash flow is always the question at the tip of everyone’s tongues.
What is a capital growth strategy?
Capital growth is the appreciation in value of a property over time. This is calculated by subtracting the future value of the property less what you paid for the property.
Remember, that the future value of the property cannot be guaranteed.
If you are applying this capital growth strategy to your next property purchase, you are purchasing a property for the long term.
With a capital growth strategy, you often need to sacrifice cash flow and yield in order to benefit more in the long run.
What to look for:
- Areas that are primed for future growth, for example, migration, population increase;
- New schools, shopping centres, hospitals, entertainment facilities (sports fields, music venues);
- Accessibility, such as bridges, train stations, airports, new roads, bypass roads, etc.;
- Low vacancy rates, increasing population.
What to avoid:
- Single-industry towns are too risky (mining);
- Lower socio-economic areas;
- Areas that have already reached their peak/already boomed;
- High vacancy rates.
What is a cash flow strategy?
The term cash flow in property investing refers to how much rent you are receiving compared to how much you are paying for the property.
This is how much cash you are left with at the end of the day after you have ‘serviced’ the property (paid the mortgage and all the expenses). Property investors use the term ‘yield’ as a reference to be able to compare returns on properties that are at different purchase prices, and different rental amounts.
Yield is calculated as the annual rental income divided by the property purchase price.
Cash flow, as an investment strategy, is preferred by investors who want enough cash coming in from their investment property to cover the property expenses. These types of investors want short-term gains, at the sacrifice of long-term returns, as higher cash flow properties usually come at the sacrifice of capital growth.
Another benefit of a cash flow property is that the property can pay off itself, as well as make you look attractive to lenders for future property purchases. Cash flow properties are a great way to increase your borrowing capacity and build up a portfolio.
But, having only cash flow properties in your portfolio will really sacrifice the potential of your portfolio growth in the long term.
What to look for:
- Properties with secure tenants;
- Properties with yields greater than 5%;
- Low maintenance properties;
- Low vacancy rates.
What to avoid:
- Run down properties needing constant repairs;
- Properties needing major repairs or renovations;
- Areas with high vacancy rates.
Can you have both cash flow and capital gains?
Yes, there are some properties out there that do have both good cash flow and yield alongside capital growth potential. These properties are usually in more rural areas that have a lot of development and multiple industries.
These rural areas also usually have an airport, private schools and universities, and a good health system available to make the area a desirable place to live in, so the rental market is in demand and future migration will assist with the capital growth.
Because these properties in rural areas are at a cheaper price point than the capital cities, you may be able to afford a little gem that offers both capital growth and cash flow, but due to the price point of the property, you will not be seeing the same hundreds of thousands of dollars of capital growth returns compared to an over one million dollar property purchased in a hot suburb of Sydney or Melbourne.
When growing your investment portfolio it is important to have it balanced and not focus on only one type of property.
You should reassess your position and consider what type of property would be best suited to your portfolio as a whole to help you to grow your portfolio and move forward.
Employing professionals to help with your financial structure and purchase strategy will really set you on your best foot to property investment success.
Article source: Queensland Property Investor
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