The Australian Real Estate market consistently delivers wealth preservation benefits and plays a huge role as a wealth strategy either in combination with other asset classes or as a sole investment vehicle.
The number one reason why people invest in real estate is capital growth. Property has historically proven its ability to deliver capital gain, provided it is in a high growth area, has owner-occupier appeal, and lies within the correct supply/demand ratio. What this means is that a property should appeal to owner-occupiers, be something that people want to purchase to live in, and will produce competition with other owner-occupiers to be able to purchase it.
There are off course benefits to investing for cash flow too. Positive cash flow properties outweigh the holding costs and produce cash flow for the investor that can assist in serviceability when purchasing and possibly the ability to hold the asset.
Although the decision to invest for capital growth (buying time) or for positive cash flow is a personal one and depends on personal affordability and serviceability issues, it is important to discuss the long term benefits for both types of investing.
The downside to investing for positive cash flow properties is that these opportunities tend to be in lower socio-economic suburbs, so the risks of positive cash flow investing are: If there is no owner-occupier appeal, the investment will rely on other investors, making the exit strategy relatively risky in a stagnant down market. Also, as positive cash flow areas have a very high investor-to-owner-occupier ratio, multiple investors selling properties simultaneously can create a stagnant market. Ghettos are created by markets that have been stagnant over the long-term in markets dominated by low socio-economic investors.
Just consider for a moment why a property would be positive cash flow. Why would a tenant pay more money to rent a property than it would cost to service a loan if they had purchased it? The obvious answer is that they are unable to purchase that property because they do not meet the standard lending criteria to do so. For a property to be an ideal investment, it needs to have some degree of growth. If there is no growth over a long period of time, then the investor will be left exposed to debt unless the additional cash flow is invested back into the loan to reduce the debt.
Long-term study: Capital growth vs positive cash flow
There are many schools of thought in relation to which strategy is better, positive cash flow or capital growth. While the answer lies in individual circumstances, and the best strategy is different for everyone, the following study demonstrates what can happen to a property portfolio over time. Consider two investment portfolios, one that was purchased for strong capital growth and one that was purchased for positive cash flow. The chart below shows the performance of the property portfolios over a 20 year period.
Table 1 shows an illustration of 37 positive cash flow (high yielding) properties versus 17 properties poised for higher capital growth. Calculations performed by Jan Somers PIA 1 software. Chart provided by Chris White – property advisor / financial educator.
The above table clearly indicates that over the long-term, investing for capital growth or investing for positive cash flow makes little to no difference. Positive cash flow properties, at least in South Australia, tend to be located in lower socio-demographic areas and therefore have a higher number of vacancies, more rent defaults, and more maintenance issues. On the other hand, high growth properties have higher loan-related holding costs (properties in low socio economic areas also have high holding costs if rents are in default or the property has been damaged by tenants and both of these scenarios are more prevalent in low socio demographic areas but can occur everywhere).
The most important consideration here is not which portfolio performs better, or which is a better strategy, but that both portfolios were given time to perform. Property is a long-term investment strategy. If exited in the short-term, say after five years, it is common to experience a loss rather than a gain.
Another important consideration is based on individual circumstances, the most important of these being the ability to service a loan in higher growth areas, given that these properties are also higher priced and have lower rental yields.
A good strategy is to build a property portfolio that has an overall positive cash flow, and that has a mix of properties, some of which are poised for capital growth and others which are high-yielding properties to help balance the cash-flow shortfall of holding high growth properties, at least in the early years of the portfolio.
My own personal investment strategy is to invest in properties that are poised for capital growth in areas undergoing gentrification and that have future development potential. These properties are usually negatively geared and associated with higher holding costs, the costs are offset by building cash flow positive businesses (not positive cash flow real estate). The point to this is that there is not one strategy that is better than all others and what works for you will depend on your own financial situation and personal skill set.
About Xenia and ALEXA Real Estate
Xenia is the Principal and CEO of Alexa Real Estate www.alexarealestate.com.au. Xenia developed alexa real estate from concept in 2006 and it has now expanded to a rent roll of over 300 properties and 10 staff members and the company enjoys massive growth every year due to a strong focus on specialisation and solving difficult, specialised property management problems
See Xenia’s real estate blog here: http://blog.alexarealestate.com.au/
Xenia is also an entrepreneur, has developed several businesses in the areas of real estate and self development and is married with 3 children. Xenia loves to share her passion through writing and has written books on in the areas of millionaire mindset, emotional resilience and human consciousness. She has appeared as a keynote speaker on many stages around Australia and overseas including sharing a stage with Bob Proctor at a wealth creation conference in Europe.
Xenia’s books:
Don’t believe everything you think or feel: https://www.amazon.com/Dont-Believe-Everything-THINK-Feel/dp/1507594895
Your Inner Journey to Wealth:
https://www.angusrobertson.com.au/books/your-inner-journey-to-wealth-xenia-ioannou/p/9781456854294?gclid=EAIaIQobChMI3oeky-qN2gIVGiUrCh0l1woWEAYYASABEgLaLfD_BwE
Prior to discovering her gift in developing businesses Xenia was a medical research scientist obtaining a PhD from Flinders medical centre followed by a 3 year post doctoral fellowship at the university of Saskatchewan, Vaccine and Infectious Disease Organisation in Canada. During her post doctoral years Xenia published 8 medical research papers in top medical journals and travelled around Canada and the USA speaking at scientific conferences about her, now patented, vaccines and research.
Other social media pages:
FB: https://www.facebook.com/xenia.ioannou.33
LinkedIn: https://www.linkedin.com/in/xenia-ioannou-290898143/
Twitter: https://twitter.com/XeniaIoannou
Blog: http://blog.alexarealestate.com.au/
