What is Capital Growth vs Cashlflow Positive Properties

I will quickly define these two concepts of cash flow and capital growth as they apply to property investing.

Cash flow

This is the difference between how much money it costs you to own the investment and how much money you get from it.

Case Study: negative or positive?

So if you pay $20,000 a year on the investment home loan, rates, and property maintenance and receive $14,800 a year in rent, your cash flow is minus $5,200 each year, meaning that it costs you $100 per week to own this investment.

You are said to be 'negatively geared' in this situation because you can reduce your taxable income by $5,200 when doing your tax and get a tax refund. Whereas, if you were making $100 a week, you would be ‘positively geared, and you would pay tax on the extra $5,200 each year.

Capital growth

This is the value by which the investment increases. In a perfect world, your investments make you money while you own them (are positively geared) and are also increasing in value. With property investing, the goal is to minimise your expenses while the rental return increases over time, slowly moving you from being negatively geared to being positively geared, so you can then afford another investment property.

Case Study: working out your return

If you bought an investment property for $400,000 and sold it 10 years later for $600,000, you would have made $200,000 in Capital Growth. In this example, you have spent $52,000 over ten years to own the property ($5,200 per year x 10 years) and made $200,000 when you sold it. So your return has been $148,000.

New vs Old

New properties require less maintenance and generally carry increased tax benefits, but older properties still have their advantages, especially if you are looking to add value through improvements or renovations.

One of the key tax advantages of buying properties built after 1988 is depreciation, which accounts for wear and tear and offsets it against your income tax.

It applies to the external structure and internal fixtures on a property, so even if your rental is pre-1988, you may still be able to claim depreciation for any renovations, including those undertaken prior to purchase.

To claim this tax benefit, you need to have a depreciation schedule prepared by a qualified quantity surveyor. This generally costs anywhere from $300-700, with many companies promising your money back if you are unable to claim back at least the cost of the survey in depreciation in the first year.

The advantages of choosing the right property

There are other advantages to buying a brand new home:

• You should be able to be more selective with your tenants, as people will prefer to live in a new home more than they would an older, more run down home.
• You should be able to charge higher rent, as you have a more desirable property.
• There should be minimal property maintenance costs compared to an older property because new properties usually have certain warranties if items break, such as dishwashers, doors, and air conditioners.

This should also be an entry-level home. A basic 3 to 4 bedroom home is the sort I would suggest.

There are four important reasons for this:

1. You want to get the maximum rent for the price of the house and land. If your house and land costs $600,000, you are unlikely to get $500 a week in rent, but a $400,000 house and land might get $350 a week in rent. There are exceptions to this, but in general, as the house price increases, the rental return does not increase at the same rate.
2. You want the widest possible rental appeal. The higher the rent, the smaller your potential pool of tenants will be. In periods of economic difficulty, the expensive rental properties become harder to find tenants to occupy.
3. By buying at a lower price level, you are going a long way towards putting a floor under the price you bought at. If a home similar to yours can’t be built for less than yours, you have as much price stability as you could hope for. It always comes back to supply and demand. Demand for expensive homes will always be tied to good economic times, but demand for affordable homes will always be strong, as long as we have a growing population.
4. You are better off owning two investment properties worth $350,000 each than one worth $700,000. You are much less likely to have both cheaper properties untenanted at the same time than you are having the single property untenanted.
5. When times like the Global Financial Crisis strike, expensive homes drop in value the most. Median house prices are also affected, but not nearly as much as the top end of town.

Cheaper investment properties allow you to diversify, so you are not reliant on a single property, in a single location, with one tenant. Instead, you can spread your risk in different geographical areas. We all know the risks of putting all your eggs in one basket.