Cashflow Kings vs. Capital Gains Gamblers

Understanding the trade-offs between rental yield and long-term equity growth

Key to building a high performing rental property portfolio is understanding cashflow vs capital gains properties and how to use these two asset types harmoniously. Depending on if you're an experienced investor with multiple properties already or just starting out and looking to ensure your first purchase makes sense in the context of a future portfolio, getting the structure of both purchasing order and property type right is the difference between headaches and money in the bank.

What are cashflow strong properties?

Properties that deliver strong rental income are "cashflow strong properties". These are properties which can usually "wash their own face"; your rental income covers mortgage payments, rates and insurance/bodycorporate and ideally any maintenance costs. Depending on interest rates, cashflow strong properties may end up still costing you out of your own pocket, particurarly recently as interest rates in the 6%-7% range have made almost all properties cashflow negative in the short term. However with interest rates on offer today and increasingly investor tailored homes such as dual key houses becoming available, these proeprties are becoming easier to find. The key to a good cashflow strong property is tenant demand and therefore resilience. You don't just want a good rental appraisal, behind that needs to be a steady stream of high quality tenants year round and fairly stable tenant pools long term. Even better is diverse income potential, such as inner city apartments which have strong long term tenant demand but also might be suitable to be run as an Airbnb type short term accomodation.

It is generally considered preferable to add cashflow strong properties to your portfolio early on, although we would caveat this with it depends on your household income, as cashflow strong properties are best suited to investor households who have high living expenses and cannot absorb high costs of servicing negative cashflow rental properties.

The trade-off is that these properties may not experience substantial capital appreciation over time. So while your yield is high from these properties, your long term growth rate is going to be lower, meaning in 10+ years time a cashflow strong property worth $600,000 today might not be worth as much as a property worth the same amount at the moment but in an area likely to appreciate more.

What might make a property grow in value more over time?

At the other end of the spectrum are properties which are in areas that historically appreciate in value more over the long term. These are usually properties in desirable locations close to city centres or up and coming locations such as new subdivisions in areas that don't currently have massive amounts of housing, therefore are cheaper but tenant demand is weaker initially.

Long term, properties in growth locations are likely to appreciate in value more. Their "income" is from the amount of profit you can make selling it in 10 years time, rather than rental income during the years you own that property. These properties can be more expensive however, particuarly when the growth location is an established/"leafy" premium suburb where property prices are higher. This is where growth locations can differ, while new subdivisions and established suburbs can both be strong capital gains locations, there is a perceieved element of safety assoicated with the established suburb over the new subdivision. This all comes down to preference and budget, are you comfortable enough with a particular location and can you afford rental properties in those locations.

Designing a balanced portfolio

Choosing between property options is about understanding what your portfolio needs at a given time. Many investors begin with an income-focused property to establish a solid financial base, then move into higher-growth assets once they have equity and serviceability to support them. Another option for investors starting out is to start with a capital growth focused property where their incomes are high enough to cover any rent shortfall.

If you're not sure what is the best move for you and your portfolio, we provide free reports showing what properties are available that fit your budget, and the forecast cashflows and long term growth data for those locations, making it easier for you to choose which is the right purchase for your portfolio. Interested in one of these reports? Email me, campbell@venning.co.nz