Is it better to focus on cash flow or capital growth in your property portfolio? While cash flow can provide immediate income, capital growth offers long-term wealth-building potential. In this article, we delve into why a balanced approach, incorporating both strategies, is essential for achieving financial freedom and early retirement.
.jpg)
Is it better to have capital growth in your portfolio or cash flow?
In my case, I always believe that we need both, but let's explore which one is actually better.
If you're interested, keep reading.
Many of you either say:
However, it really comes down to what your goals are.
Usually, people have the goal of achieving passive income, which will ultimately allow them to retire early. So, the answer should be cash flow, right?
However, it’s not as simple as that.
Yes, if your only goal is passive income, then cash flow is going to get you there. But, is cash flow alone enough to get you to your goal?
If your passive income goal is $20,000 a year, you could just go for cash flow properties—happy days. But if you're looking at ultimately building wealth and generational wealth that you can retire on and want to get over $100,000, then you’re going to need a combination of both cash flow and capital growth.
Why? Take a look at this example:
Let’s say we have:
(Let’s assume there’s no debt to make this example really simple to understand.)
Both properties were purchased for $450,000.
As soon as you see that number, you might think: High yield! Oh my God, that’s what I want to get.
Now, these deals are still available out there, but it’s not a deal that we would do under our own buyer's agency. As part of our process for our clients, it’s about long-term wealth, and you’re going to get that when you get the capital growth there.
With something like Property B, in order to achieve such a high yield, you’re probably in an area close to mining, and it’s a super volatile market—all you have to do is ask anyone who bought property in Perth between 2010 and 2012, and they’ll tell you the same stories.
In this case:
These costs would include things like property management fees.
Therefore, based on the aforementioned figures:
Obviously, you’d have to take out your ongoing costs, but straight away, you can see the difference of about $11,000 on Property B, which means: Property B wins.
So far, cash flow is looking like a pretty good option. But before you jump onto realestate.com, read all the way through, because you’re going to understand the relationship between:
Now, does your decision change?
If Property A is growing at 7%, whereas Property B is growing at 3%, well, it should, because:
This means a difference of about $18,000.
This would completely offset the gains you would make just from the cash flow, which is the $11,440.
In addition to that, the cash flow is taxed, and this is what I’ve got here:
The way it works is that if your property is growing in value, you’re not going out there and saying: well, that’s money I’m going to use right now. It’s just growing, which means it’s capital growth.
The only time you’ll really have to pay on capital growth is when you sell the property, and you pay capital gains tax.
The other advantage you have is that if the property has grown in value, and you decide to take some of that equity out, you could go and use that for another purchase. And your question might be: Well, Ravi, when I use that equity, isn’t that taxed?
The answer: Well, it’s not, because equity in your eyes is actually debt in the eyes of the bank. So, you’re actually taking out further debt, which means you can’t be taxed on debt. This is a big hack when building a scalable portfolio; you’ve got to understand your tax obligations.
I’m not a tax expert, and I’m definitely not an accountant, so definitely reach out to the people in your network to assist you with that sort of stuff.
Now, with all of this in mind, what does that ultimately mean for cash flow and capital growth?
Well, what I got taught early on was: cash flow keeps you in the game, whereas capital growth gets you out of it.
This isn’t necessarily a bad thing. The way you’ve got to think about this is that cash flow allows you to keep borrowing. It might not allow you to borrow straight away, but it could ultimately lead to greater borrowing capacity later down the track if you have a higher rental income and cash flow.
Not only that, when you’re looking at times of volatility, your main goal is: how do I hold and maintain my wealth, and preserve my wealth?
In the case of real estate, if interest rates have gone up quickly, you don’t want to be in a position where you’re like: I can’t afford those repayments.
Therefore, if you had strong cash flow that may have been positive last year but is now neutral, well guess what? It’s still not affecting your day-to-day life, which means at the height of interest rates, you’re still operating and holding your real estate.
Now, if rate cuts happen, and your rents increase, you’ve gone through the worst period from a cash flow perspective, and now you’ll realise those gains later on. The capital growth aspect is where you can multiply your wealth fairly quickly.
Why? Because it’s not taxed, allowing you to grow much quicker. That’s why if you don’t have capital growth in your portfolio, unfortunately, you’re playing the loser’s game when it comes to real estate.
You want the best of both worlds because think about it: If you have a lot of cash flow but your properties aren’t growing in value, sure, you could use the extra cash flow to pay down your debt or save up for another deposit.
However, if you had properties growing at 5% to 7%, then you’d ultimately be in a place where you could realise some of that equity to build toward another deposit.
To further understand, I’m going to show you exactly what that looks like:
As I mentioned, cash flow allows you to borrow more, and that could ultimately mean that you have a bigger portfolio.
This is the whole game here.
How do I acquire as many assets as possible?
How do I grow my machine to be a substantial size that allows me financial freedom and early retirement?
To answer these questions: you need both. I can’t stress this enough.
I’ve had people show me their portfolios and say: Look, Ravi, this has actually grown by $100,000.
I was like: $100,000 on a $1.2 million property is about 8%. If we were to get 8% somewhere else, and we had cash flow of about 5.5%, that would outperform your asset, which is only giving about 2% to 3% rental yields.
Now check out this example:
With strong cash flow, you can buy more.
In this case, if you had a portfolio worth, say $2 million, and it was giving you about $100,000 worth of rent, maybe you’re maxed out. So, in the bank’s eyes, your borrowing capacity is maxed out—you can’t do anything else.
However, if we had the same $2 million portfolio but with higher rentals at $150,000, we could potentially borrow an extra $300,000.
This means our portfolio is actually worth $2.3 million versus the $2 million we had here.
See? The way the banks look at your debt, the way they look at your servicing and borrowing capacity, there’s an advantage when you can get both.
Why? Because even if you have equity in your property, without enough cash flow, you can’t access that equity anyway. And vice versa: if you have great cash flow and borrowing capacity, you’ll have to wait until you’ve saved up enough because your properties aren’t growing in value.
Therefore:
Now, the whole goal we have at Search Property when we’re looking at properties for our clients is that we want a minimum of 5.2% yields and a minimum of 7% growth.
If you’re interested in the strategy we have, you can definitely book a free discovery call with my team.
I hope you guys have enjoyed this article and learned a lot from me!
I’ll catch you guys in the next one.
Thanks, guys!
.png){kind=icon}
.jpg)
.jpg)
%20How%20The%20RICH%20Build%20MASSIVE%20WEALTH%20Without%20Paying%20Taxes!%20(1).jpg)
.jpg)
.jpg)
.jpg)
.jpg)
