Should You Invest for Positive Cashflow or Capital Growth?

This is a question that many property investors ask themselves when considering their investment strategy. Countless articles and books have been written on the subject, each with a slightly different perspective.

There are a couple of factors to consider but first let’s take a look at the differences between the two approaches:

Positive Cashflow Strategy:

A lot of people don’t realise that there are significant costs associated with purchasing and maintaining an investment property; mortgage payments, building and landlord insurance, repairs and maintenance, leasing and advertising fees, property management fees, utility charges, council rates, additional tax return fees and sometimes you also have company/trust fees and land taxes. In most cases, especially in the initial stages of ownership, the vast majority (if not all!) of your rental income will go towards covering these costs.

The main goal of a positive cashflow strategy is to ensure that the income from your property exceeds these expenses. There a couple of way to achieve this; either by targeting high-yielding properties or by increasing your deposit when purchasing (and thus decreasing your borrowings and mortgage payments).

While ideally you would have both positive cashflow and capital growth, the priority with this strategy is to receive money each month and to ensure that you don’t have to continually “top-up” your investment with additional funds. This also improves serviceability which can help with future property purchases. Proponents of this strategy will focus on "the numbers" rather than the location of the investment property and this will often lead them to outer-ring suburbs of capital cities or regional areas where yields tend to be higher.

Capital Growth Strategy:

The focus of this investment strategy is to target properties that have the highest potential for capital growth. Cash flow is less important, and usually the investor will have sufficient earning capacity (or appropriate other means, such as a line of credit taken out on an existing property) to make extra contributions when required.

The idea is that the equity gained through capital growth will exceed the additional costs and/or rental deficit over time. Generally, this will mean targeting suburbs within the inner and middle ring of major/capital cities where there is limited land available and where the majority of people want to live.

If the property is negative cashflow, the investor will also get a discount from the tax office as the annual loss will be deducted from their income on their personal tax return. Some investors actively seek out this scenario in order to maximize their deductions at tax time, however in my opinion this should not be the primary reason for any investment decision as you are still losing money - a discount on a loss is still a loss!

Which is best?

While cashflow must be carefully managed, I believe capital growth is the more important consideration when deciding on your next property purchase.

The reason is simple: The goal of any property investor should be to increase their equity as fast as possible, and capital growth of your property is more likely to achieve this.

To determine why, let’s take a look at a few simple examples (with assumptions):

1) $500k Property Purchase

Assume a purchase price of $500k with a 20% deposit of $100k, 5% capital growth per year, a yield of 6%, and an interest rate of 4.5%. 

After one year, you have $500k x 5% = $25k more equity from capital growth (not taxed until you sell the property). The rental return is $500k x 6% = $30k per year. The mortgage repayments are $400k x 4.5% = $18k per year. Assuming other fees and expenses of $8k per year, you are left with ($30k - $18k - $8k =) $4k of positive cashflow (roughly $75/week).

Therefore, after one year,  the capital growth has increased your net worth by $25k, while the positive cashflow has only increased your net worth by $4k (before taxes!). For a $100k deposit, a 25% ROI in the first year is a pretty good start!

2) $1m Purchase – Two Options

Suppose you have no mortgage on a property that you have purchased for $1m and I gave you two options, either you can have 4% capital growth and 6% rental yield OR you can have 6% capital growth and 4% yield. Which would you choose?

You may think it doesn't make any difference as either way you are getting a 10% gross return on your money; after one year, your total equity will be $1.1m (ignoring expenses). However, let’s take a look at the numbers compounded over a 20 year period:

After 20 years, you can see that the property with 4% capital growth has increased in value to ~$2.1m, however the property with 6% capital growth is worth over $3m! A small difference in capital growth can have significant effects when compounded over time. Even with the sum of the difference in rental income of ~$300k over the 20 years, you are still ~$600k better off.

Also notice that the inferior yield of 4% is relatively similar after 20 years! This is because the yield is based on the property's value and thus rises at a faster rate when combined with an increased rate of capital growth.

Over time, a well located “capital growth” property will deliver a significantly improved yield from a dollar perspective, but a “positive cashflow” property in an inferior location is unlikely to deliver increased capital growth. I rest my case!

If you want to get in touch, please send me an email:

micahkg@gmail.com