When it comes to property investment, there are two key paths you can follow. Either a long-term capital growth focus or a strategy with a positive cash flow focus. Although possible, it is rare to find an investment property that achieves both. So before investing, it’s recommended to choose one of either strategy, and start your search based on your desired investment outcome.
Simply, a capital gains investment strategy is when you have the goal of making a profit through the sale of the property due to its increase in property value. In most scenarios, this strategy involves ongoing property expenses (such as interest payments, maintenance, insurance and council rates) being greater than the rental income generated. This is also known as negative gearing.
This strategy is favoured by long-term investors and those who have enough income to supplement a secondary property.
Tax deductions: Because your property will be losing money on a week-to-week basis (negative gearing), you may be eligible to claim these losses through your tax return at the end of the financial year. This means for example, if you earn $60,000 per year, and have a loss of $10,000 on the property, you may be able to offset this loss against your salary, reducing your end-of-year taxable income to $50,000.
Long-term return: The main advantage of a capital gains investment strategy is its higher return. As the property value increases over time, so does your potential return, making the timing on your decision to sell the most important question.
Covering expenses: Because you’ll be making a loss on the property, you’ll need to dip into your own salary to cover the difference. This can be tricky when things are already tight.
Capital gains tax: When you sell, you’ll likely make a substantial return on your property, which is then taxed by the government. This taxation will affect your total return on investment and should be accounted for before selling.
Long-term strategy: Because capital investment is a long-term strategy, you’ll need to give your property time to build value. This means there is a chance you’ll see no positive return until you sell, which for some isn’t an option.
If you’re considering a capital gains investment strategy, you can expect to find the perfect property near a main city or town or major areas of construction and development.
If cash flow is a priority for you, then a rental return investment strategy is what you’re after. This strategy is where the rent from your property covers the maintenance costs, while also leaving you with extra cash from week-to-week.
This strategy is typically picked by new investors, or those looking to build their investment property portfolio quickly.
Costs covered: The main attraction of a rental return strategy is the return of cash flow. As long as your property has tenants, you’ll be generating a secondary income, opposed to stumping up cash through a negatively-geared capital gains strategy.
Positive cash flow: Because you’ll be cash flow positive, you’ll be able to meet repayments easier and pay off your mortgage faster. The additional income means you can improve your buying power, which further increases the likelihood of lenders being willing to lend to you in the future.
This allows you to continue to build your property portfolio or reinvest in a larger home or holiday for yourself.
No tax deduction: As you won’t be generating a loss on the property through negative gearing, you’ll be required to pay tax on the excess income, which minimises your potential return.
Short-term strategy: Because your property is focused on cash flow, it’s likely the long-term capital gain will be lower than those who follow a capital strategy.
In the end, both strategies have their own advantages and disadvantages. It really comes down to what you’re after, your long term outlook or your current financial position.
It’s always best to speak to a financial expert before diving into any large investment decision.