Why investing for cash flow is more important than capital growth

The old debate over whether cash flow or capital growth is better is, I think, silly. Let’s look at real estate as the investment vehicle of choice here for putting some money away in an investment, and you’ll see why I’m saying what I’m saying.

Let’s say (for a simple example), that you have $100,000 to invest. You need to decide is what to do with it, and the next question is – what do you want from your investment?

Investing for capital growth
If you’re happy putting that money away by buying a property and then hoping for a price appreciation down the track so that when you sell you have increased your original figure, then that’s great – but be careful. Something I’ve noticed among real estate investors who buy for capital growth of their investment is that they fail to consider a couple of vital factors.

These are inflation and the Consumer Price Index (or CPI). These two things basically influence the value of your money. Simply put, if the value of the property doesn’t go up by the time you sell it, you haven’t broken even, you’ve lost money, because with the passage of time your $100,000 is no longer worth that much. That’s without considering all the fees and charges involved in buying and selling the property, which will also put a sizeable dent in that $100,000.

CPI vs PPI - 1 Year Chart | Thumbcharts.com © by thumbcharts

Investing for cash flow
So, looking at investing for cash flow now, you will have to consider the rental return on any property as well as a bunch of other factors like local vacancy rates, parks, schools, transport, shopping, sporting facilites and other infrastructure. These will influence what area you buy your investment property in. What you want is to maximise the return on your money (in rent received) while minimizing your exposure to risks (like having a vacant property, or one that needs a lot of maintenance expenditure).

What you want from a cash flow investment property is something in a reasonable condition in a decent area with high occupancy rates. Another consideration of course is whether you have obtained finance to fund your purchase. If you have, then you will need to consider the cost of repayments when calculating whether the purchase is financially viable.

Investing for both cash flow and appreciation is ideal
When you’re looking at a property, be sure to consider both the possible rental returns and cashflow, as well as the potential for capital growth into the future. The ideal investment property is one that delivers a decent cash flow to your pocket on a weekly basis, as well as capital growth as the property rises in value. Don’t put all your eggs in one basket.

Looking at the numbers alone, your property will have to increase in value by more than 2.7% to beat the increase in CPI (based on March 2012 data) and then you’ll have to calculate for inflation on top of that, and that’s before you can count on any profit at all. Can you really, honestly, look at the real estate market as say that your property can deliver such consistent results, year after year? I’m guessing your answer will be a big “no” – and that’s why cash flow should not be forgotten. It’s not everything, but it’s half the equation that I use when deciding whether an investment property is worth buying.

What about you? Do you like cash flow or appreciation better for your investments?

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