Property investment can build wealth. But what are the specific strategies you should consider? Whether you’re just getting started on the property ladder, or already have a few properties in your portfolio, the investment decisions you make will be the difference between success and failure. Here I look at three common strategies and how they work.
The capital growth strategy
The capital growth strategy aims to build wealth through gains in the value of your property. While there’s no guarantee of capital growth, buying right could boost your chances. For example, properties in big cities like Sydney and Melbourne have risen in value over a fairly short period of time – growing 75% and 59% respectively over the past five years – they have also declined in value quite suddenly. So, where and what you buy can impact capital growth.
The capital growth strategy could involve a negative gearing element. This means your deductible expenses, including things like interest on your loan for the property, is more than the rental income you’re generating from the property. Since you have a net rental loss, you might be able to claim this loss against your other personal income (including salary).
Capital growth vs cash flow strategy
Some experts recommend the capital growth approach over the high yield or cash flow strategy (see below) because over time, higher capital growth tends to build significantly more wealth.
How to find capital growth opportunities
Property values can also rise with strong economic growth, as more job opportunities seem to generate demand for housing. At the same time, insufficient development could restrain supply, in turn increasing property prices. Also, look for properties located close to amenities like schools, shops and public transport as buyers often prefer these properties.
The cash flow strategy
Pursuing a cash flow strategy means you look for properties with high rental yield potential. Typically, this involves buying properties that offer enough rental income to cover your expenses. Your rental income should cover everything from maintenance and repairs to mortgage interest and property management fees. Any additional income over these costs is then directed to your mortgage repayments.
While these cash-flow optimised properties – usually found in regional areas or on the outskirts of cities – are cheaper to buy and hold, they may offer less overall return in the long run compared to the capital growth strategy. However, you could potentially access more rental income on a regular basis and have more income at hand to cover unexpected expenses associated with owning a rental property.
Is the cash flow strategy right for you?
Whether or not you choose the cash flow strategy could depend on your goals. For example, if your aim is to eventually retire and live off your property income, the cash flow strategy could suit you. This could take as much as 20 years before retirement to achieve, so planning ahead is essential. Alternatively, your goal might be to afford a property and get on the property ladder by ensuring rental yields cover a good amount of your costs. If so, the cash flow strategy could be right, as it helps you maintain mortgage debt reduction via rental income.
Note: if you’re earning a positive income from your rental property, you won’t be able to claim negative gearing tax benefits, so you’ll be paying tax on your rental profits. Given the high transaction costs and deposit requirements associated with buying property, it’s essential to consider the numbers and do the due diligence to make sure the cash flow strategy will work in each particular case. Some experts suggest the cash flow approach could be impossible in Australia, so investors might need to adopt a modified form of the cash flow strategy.
The flipping strategy
Flipping houses to create wealth means you buy the property with the intent to sell it to make a quick profit, as opposed to buying and holding for the long term. You could realise a profit from capital growth, by making capital improvements such as renovations. The classic example is buying a rundown fixer-upper in an in-demand suburb, investing in renovations, and then selling it at a high price thanks to the substantial improvements and proximity to amenities.
If you do it right, this type of strategy could give you a quicker return on investment than other strategies. However, the risk of losing money is higher, especially when you take the costs and taxes associated with buying and selling (including capital gains tax, mortgage repayments, and stamp duty) into account.
Which strategy is right for you?
Your strategy could involve the cash flow approach and the capital growth strategy. There’s no single correct answer. It depends on your circumstances and goals. Get to know the different strategies and consider your situation. This information is general in nature and it’s also a good idea to speak to different financial advisors and work with a mortgage broker as you look for the right strategy and the right property for your circumstances.