Buy this time for Capital Growth or cash flow?

Hi everyone,

I'm looking to buy my 4th investment property but I'm in two minds which way to go. Buy for capital growth or go cash flow?

I know it's a decision based on many factors and circumstances and it's hard for anyone to give a definite yes no answer, but I'm after your thoughts, opinions and advice to help me out.

My circumstances:

The three properties I have at the moment I have bought over the past 3 years:

- 2 capital growth (positively geared as well) in Sydney and Brisbane.
- 1 cash flow (10% yield) in regional NSW.
- I've used part of the equity in Sydney property and my added income from number 2 to fund Brisbane one.
- waiting and hoping for the Brisbane one to keep heading up. Not as fast as Sydney, but hoping all the same !
- borrowing capacity is getting limited now, so this will probably be the last purchase for a while based on my current circumstance. I obviously want to increase my chances of borrowing more sooner rather than later.

Soooooo.......

I've been looking around and looking at my options. This is what I've got:

1. Buy another cash flow property in regional location, well within my borrowing capacity. Figures are good. 11% rental yield in sound rental market. Limited capital growth options though.

2. Use all my borrowing capacity to buy another capital growth property in Brisbane with neutral gearing.

3. Look to buy a cheaper property in regional/semi regional area where I can add value by home improvements and adding bedrooms etc etc (therefore having to use up some of my savings), well within my borrowing capacity, in slow moving growth area, but with sound 6-7% rental yield?

My initial thoughts:

- my first buy was the Sydney one (capital). My second was the cash cow in regional NSW. My third was the Brisbane (capital). So far this order if capital, rental, capital has worked for me, so I'm tempted to continue and look for cash flow.

- having another cash cow will add to income and ability to borrow for the next one, and I like having them as a buffer should rates and things go belly up at some stage.

- my end goal which I'm aiming for would be to hold as many properties as I can, have enough positive equity properties giving me an income to finally not have to work, whilst having some capital investments to have for a rainy day or to pass on to kids. I'm 40 so I'm not sure if I should be driving for the cash flow rather than capital?

What would you do and why??

Thanks in advance for your thoughts.

 

If your end goal is to build and hold the portfolio and develop a passive income, and you are nearing your servicing ceiling, ask yourself - what good is equity from growth during this point in your wealth building plan?

I believe firmly that in order to build a large enough portfolio to produce a passive income for life , you need to keep manufacturing BOTH borrowing capacity and equity simultaneously . Borrowing capacity for obvious reasons - borrowing capacity! And equity to fund deposits and costs.

What is often forgotten is that equity isnt only the result of an increase in the value of an asset. It can also be the result of a decrease in the debt secured by that asset .

I give you apples v apples;

Apple A purchases a 500K asset with 400K debt that grows in value to 800K. Apple A thinks "wow!, I have 400K equity. ...how wonderful... all this equity means I can call my bank or broker and buy Property # 2" But Apple A had ignored cash flow and still owed 400K , so their bank or broker tells them Mr APRA wont lend them enough additional money to get Property #2. You see, their borrowing capacity has not improved, aside from the modest improvement achieved through CPI salary increases and rental increases.


At the same time, Apple B also purchases a 500K asset with 400K debt, but that asset only grows in value to 650K. Apple A ought to be disappointed. After all, most of the other Apples have been banging on and on about growth being all that matters... Luckily for Apple B, they understood that Mr APRA required a different approach, and they had focused on NRAS or dual occ or some other form of high yielding approach when they purchased that 500K asset. The reward of that forward thinking had meant that the debt had reduced from 400K to 250K. Apple B thinks to itself.." sure, Apple A got better growth than me, but I have also got 400K equity, so Im just as equity rich as Apple A, and I have less debt, so I have better borrowing power than Apple B" So as Apple A complains about not being apple to harvest any of their equity, Apple B calls their broker and Mr APRA doesn't get in the way of their next purchase... And Apple B realises that 2 high yielding 500K assets growing at half the speed of 1 x blue chip 500K asset, better addresses Mr APRA ... and if you extrapolate this out over 4, 6,8 purchases.... the cash flow orchard beats the equity orchard in the end game....

In other words, given the same borrower, same income, same rent, etc... debt reduction ALWAYS beats GROWTH when borrowing capacity is the question . less growth. same equity. better borrowing capacity. And the only fool proof way to achieve this without selling things is debt reduction. That is unambiguously true And that means all roads lead to higher yields being more important right now...

Now, if your end goal was to trade ..buy, sell, pursue growth etc... get lucky enough for long enough that you get a large enough pool of funds to reinvest profits in EFT's or LIC's and manufacture a passive income that way... different story possibly. But that strategy carries capital preservation risks which are significant in such a volatile post GFC , low rate, low growth, low inflation environment as we are entering now... but if we want to be balanced in this discussion - if that pays off/works out , it is certainly far less work than a large property portfolio

We have entered really interesting times - where for pretty much the first time in 3 decades you actually cant just assume that you can continue to harvest equity and continue to borrow, and continue to grow. You've actually got to start really looking at what value equity holds when you cant get to it because of servicing ceilings.

So for me... chasing growth now ( in these times specifically - ie right now, low rate, post APRA, and for the foreseeable future, and before you have accumulated sufficient properties to get where you want to go) should be the domain of the mature portfolio owners for whom the cash flow is already built and delivering, or the very high income earners , only... as both those groups can largely avoid Mr APRA. But for those starting out, or with modest portfolios and average incomes... and who are hoping to get to a passive income large enough to retire... growth wont help you one little bit when you run into Mr APRA. So the balanced approach you are taking seems a very sensible one...

 

Lol always love your examples. Next time, could you work in vegetables instead of apples?

 

The decision always has to come back to your bottom line for cashflow to hold the property/s, and the risk to one or all of them if the whole thing goes south somehow.

Not much good buying a CG property if you are so strapped for cash that your lifestyle (and mental health) suffer.

It is always wise to try and structure the purchases so that one doesn't endanger the rest.

 

Really appreciate your reply Euro. Lots of excellent advice, thank you.
My gut, and brain is suggesting cash flow. Always good to get confirmation though.
Would welcome other's opinions too please, no matter what it is.
Thanks again.

 

Completely agree with you Bayview.
I've been lucky so far with things and don't see the point in putting myself and the family under undue stress.
Again, thank you.

 

I may not be getig the whole picture but why to purely target cash flow or growth.

You can pick stuff with potential and 5% growth. Wont that fit the purpose?

Why would you need to go regional? 5% cash flow with 5-6% yearly growth is 11% initially with a potential to improve. I feel such properties are a good bet if youwant to gamble.

Regards

 

I always like the strategy of investing for growth and sourcing required cashflow elsewhere.

 

Yes, I see your point ashish, but some of my best options for cash flow are in semi/regional areas. There are a couple of options of 7-8% purely cash follow with an option of adding value through improvements (increasing rent at the same time) but this eats into my savings which is not ideal as this stage. Would rather wait to borrow against my capital investments rather than use my savings or to build up my savings further with cash flow properties and use that.
I'm thinking my best alternative is to possibly look at the 11% rental income at this stage to improve borrowing power. Got some due diligence to do on this yet.
As Ace in the hole suggests, I too like to keep it simple and keep cash flow and capital properties separate. Not always possible I know since capital areas tend to be more pricey.

 

Okie, if you are ralking about gross yield.

Why not target brisbane or adelaide. Lot of potential and good yields. Though not 11%, but yield eventually will improve. Growth on the other hand will be a bonus.

But that's just me. I think if you feel it is good for your portfolio, go for it.

 

I'm confused.. so did the second Apple know that his brother was setting him up?

 

Dont be confused... eat an apple and keep the confusion away

 

How about buying properties that are neutral and set for growth and can have duel occupancy added in later.After development sell one off and use the profit to pay down debt or hold and increase yield.

 

Provided you can be certain of having the borrowing capacity to do so... it can be a good way to go.

 

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