There are two components to the returns from investing in property—capital growth and rental return.
Some property investors regard themselves as ‘growth’ investors, looking more for property that will increase in value quickly and substantially. Others are ‘income’ investors. They would rather the rental return covers all the costs associated with owning the property so that it doesn’t cost money out of their own pocket every week.
Arguments often break out between proponents of these two approaches as to which is the best approach—to invest for growth or cash flow? It’s important to remember that the two are not mutually exclusive. It is possible to invest in property that returns both strong positive cash flows and good capital gain.
You just have to find it—and often be patient and wait for it.
It’s important to remember that property is a medium to long-term investment. So the yields will change (as a percentage) over the life of the investment. A property that is cash flow negative when you buy it may well become positive as rents increase and your loan gets paid off (providing you choose a principal and interest loan—which not all investors do).
Most new capital city properties will not return a positive cash flow when you first purchase them. The rents are not high enough and the property prices are such that the rental yields are quite low in terms of a percentage of the purchase price of your investment.
Remember though, that depreciation allowances on newer buildings are higher and, depending on which tax bracket you are in, the tax deductions you can claim from depreciation on the building and plant and equipment at the property can make a difference to the overall returns from your property investment. If you are considering buying off the plan, the developer will often provide you with a depreciation report so that you can calculate the allowances you will be entitled to claim and how this may affect your cash flow.
Well-located, quality real estate in capital cities will usually (all things being equal) attract good tenants and enjoy low vacancy rates, so the cash flows will be consistent and continuous, while you wait for that capital growth to kick in.
The graph shows home value growth in Melbourne, Sydney and Brisbane since 2008. (Source: RP Data)
In regional areas, it’s possible to locate lower-priced property with comparatively high rental yields and this is a strategy that many ‘income’ investors choose. Regional areas however, collectively, have not historically enjoyed the same capital growth as capital city properties.
It’s not wise to generalise, as the regions are so vast and their economies and growth drivers are very different. Mining towns are ‘regional’ and many investors have enjoyed stellar short-term growth and unbelievable rental returns in these areas, but those areas are generally regarded as high risk.
Of course, any capital growth is taxable when you sell your investment property as you will be liable for capital gains tax (CGT). Capital gains tax is discounted by 50% if you have held the property for more than 12 months and you have purchased the property in individual or joint names.
To summarise, the best investments are those that offer both good capital growth over the medium to long term and strong consistent cash flow that becomes positive over the time you hold the property.