Cash flow or capital growth – which is better?

Whether to buy property for cash flow or for capital growth is a long-standing discussion. At the end of the day, you need both as an investor.

Whether you are investing for cash flow or for growth ultimately depends on how old you are and how long your investment horizon is. The older you are and the shorter your time frame, the more important cash flow is, and vice versa.

However, which type of investment will perform the best over time?

What is the difference between a Cash Flow vs A Capital Growth Property?

Firstly, defining some key terms:

Yield: means the % of rent generated on the property. High “yield” properties tend to be less expensive properties in secondary areas that spin-off good cash flow.

Capital Growth: a high growth property tends to be a more expensive property in a capital city location with a lower % yield. These properties tend to be purchased with more debt, but with more economic drivers creating demand and pushing the price and the rent higher over time.

So, not to oversimplify the topic, to some degree we are talking about regional properties (cash flow) vs capital city properties (capital growth).

What about “risk”?

Some investors only think about “yield” as “cash flow”.

However, the yield is not just cash flow; yield reflects risk. It is critical to understand that if you are chasing yield, it means that you are simultaneously chasing risk (and the yield is compensating you for the added risk).

Take an extreme example, by comparing Broken Hill in western NSW, and the inner Sydney suburb of Paddington. The yield in Broken Hill is around 9%, whereas the yield in Paddington is about 2.4% (house).

While the Broken Hill property will spin-off cash flow, this is compensating you for the higher risk of holding that asset. Without population growth, there may be higher periods of vacancy in Broken Hill.

Conversely, the Paddington property will grow in value over time.

So, there is a trade-off: more cash flow and higher risk; vs less cash flow and lower risk.

What will grow your wealth more?

Cash flow will keep you in the game, but capital growth will increase your net worth.

This is due to the power of compounding or “growth on growth”.

Consider two investments, both purchased for $500,000 on the same day.

As we can see while both investments grow, the growth of the capital base is more valuable than the additional cash flow. Interestingly, Property A also becomes a cash flow property over time, as both its value and the rental income grow.

Conclusion

Cash flow matters (particularly in the post-APRA changes), and ultimately, “cash is king”. Both strategies can work and have their place.

My focus is “net worth”, and you only get that from assets that grow in value.

A good strategy is called “pairing”: buying two properties with opposite characteristics. One cash flow, and one growth property.

Remember though, you can get yield in the capital cities, however, this involves a more “active” investment strategy (renovation, development). I have helped clients find these sorts of properties in Sydney.

A good buyer’s agent and property strategist will be able to help you decide which property profile suits you best. So for an obligation free discussion about your property goals, please contact me on john@bridgetobricks.com.au