Capital Growth or Cash Flow?

By Neil Vorster  When one invests in property, one does so for two reasons, firstly to create wealth and secondly to create a passive income. Which one is more important? If I was asked this question a few years ago, that is before the sub-prime crises in the USA, my answer would have been an unequivocal "Capital Growth of course!" I have said many times that you need to watch the cash flow, but the real power of property is capital growth...Am I right? Let’s look at the two components; assuming of course that we can we separate them.

Capital Growth

When you invest to create wealth or as we like to say at Organic Growth, to transfer wealth, surely capital growth is the name of the game? If you purchase in a fashionable growing area like Sandton or an up-and-coming area like Fourways or Sunninghill it is reasonable to expect that your property value will increase at a rate higher than the national average for property. The benefit of achieving capital growth is not only the profit you will make on the sale of your property, but also the option of refinancing your property and unlocking some of your equity when the need arises. In the current banking environment, 100% finance is hard to come by and 90% bond finance is more likely. When you purchase your second property one can obtain the “cash deposit” from property number one. This way you effectively purchase property number two  with 100% finance. And we know that investing with OPM (other people’s money) is the ideal way to invest.

Cashflow

Recently the likes of Robert Kiyosaki and company, having experienced the USA property crash, are warning against investing for the sake of capital growth. Don’t mistake their warning, they are not saying that capital growth is not attractive; they are saying that if you are aiming to speculate by buying low and selling high to make your profit, beware, the market might turn on you and leave you high and dry. They are however emphasising the cash flow component of your investment as a primary decider. Does that mean that they would advocate investing in a suburb like Windsor, Randburg, which has experienced extreme degradation over the last 20 years? After all, it will provide amazing initial income returns with more than enough rental to cover your bond and levy costs.  Absolutely not! You can expect the rates and levies to increase steadily, rentals to grow slowly and the value to grow even slower. In addition, the caliber of tenants in this area will ensure an irregular rental income at best.

So where does that leave us?

Investing in Sandton will give the best capital growth and rental growth, but will place a large burden on your cash flow in the first few years of ownership  while a suburb like Windsor will give best initial cash flow but poor capital growth . Do we invest for the sake of cash flow or capital growth? My suggestion is go for something in between. A property that doesn't break the bank but which offers good capital growth PLUS  reasonable rental income returns.  Fortunately the property fundamentals which provide good capital growth will generally ensure that your rental grows too. I have found suburbs like Fourways, Northriding offer this perfect combination! These Gauteng suburbs illustrate this phenomena well but the fundamentals apply in most cities. Before you buy, do your homework to find the best combination that suits your needs. Which side of the fence do you sit on, Cash flow or Capital growth? Your comments below would be most welcome and beneficial to other readers.    Image courtesy of [arztsamui] / FreeDigitalPhotos.net