Property investors tend to focus on cash flow and capital gain, but it is difficult to have both. This is because in Australia, positive cash flow properties appreciate relatively slow and negative cash flow properties appreciate relatively quick. Therefore, investors are always torn between a high cash flow property or a high capital gain property.
Cash Flow
Properties with positive cash flow have a high rental yield, so all the expenses of the property, such as maintenance and property management fees, are covered by the rental income received, so that additional income above costs can be used to repay the mortgage and increase equity. This means that there are less out-of-pocket expenses for investors, and they may own an investment property freely with positive cash flow. In most cases, in order to find a property with a rental income that covers the costs, investors should purchase inner city apartments with high rentals, or low-cost properties in popular regional suburbs.
Pros and Cons
Properties with a high cash flow will help investors to improve their own income and borrowing capability. Investors get monthly income and obtain the return of their investment in short term. If the monthly rent is higher than the loan repayment, the extra cash can be put into an offset account, allowing the investor to slowly reduce the loan amount and own the property sooner. This type of property is generally affordable and has low vacancy rates. Even with the turmoil in the property market, rents remained stable.
Properties with high gains tend to have a slower and lower capital gain. As investors earn positive income, they cannot take advantage of the tax benefits of negative gearing and must pay tax on their rental profits.
Capital Gain
Properties with capital growth over the long term are capital gain properties. This type of property tends to be in the popular area, where people are willing to live; therefore the property appreciates quickly and capital gain will follow. Such properties are usually very expensive and the costs associated with investment property outweigh the rental income from it, meaning that the investors have a significant monthly expense to maintain the property. So it is difficult for general investors to own many properties with high capital gains.
Pros and Cons
Investors can use the cash gained from the sales as a down payment on their next property, expand their investment, or take advantage of the tax benefits of negative gearing in term of a loss on the investment property. Properties with high capital gain can be lent more as banks are willing to lend on properties in desirable growth areas. Once the value of the property has risen to a price that investors are satisfied, they can sell it so that they can speed up the repayment of loans on other investments or secure money for retirement.
However, this type property with high price will result in the investors having to spend more of their income on mortgage and their living standards will decline. At the same time, investors’ borrowing capacity will become lower and they might not be able to continue investing. Such properties with negative cash flow need to be continuously supported. If the investors’ financial situations change, they may be forced to sell their property at low to get out as soon as possible.
Summary
For property investors, should they choose a property with high cash flow or a property with high capital gain? In fact, it depends on the investors’ actual situation. Don’t just go for high cash flow or high capital gain, as both are equally important and should be combined to complement each other and achieve a healthy portfolio that will build wealth.
Any questions? Contact your professional mortgage brokers at MoreMore Finance, and conduct a borrowing power review.
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