If you’re thinking of buying an investment property deciding on your investment strategy – capital growth or rental return – is a good place to start.
There are typically two mains schools of thought when buying an investment property – buying for capital growth or rental return.
I’ve recently bought my first investment property and my own investment strategy was to buy it for rental return. That’s not to say this is right for everyone, but it suits my circumstances. If I only wanted one investment property than perhaps I could afford a capital growth investment strategy. But because I hope to buy more, I simply can’t afford to have multiple negatively geared properties.
I will try to buy properties closer to city centres not because I’m chasing capital growth but if I’m going to get any capital growth benefit I know I’d be better off buying closer to city centres.
So what does this all mean, and why can’t you achieve capital growth and rental return?
While it’s possible to achieve both, more often than not you will need to base your investment strategy on either capital growth or cash flow. Here’s an overview of each investment strategy and their pros and cons, so you can work out what would suit you best with your own financial situation and investment property portfolio plans.
Buying an investment property for capital growth
A capital growth investment strategy is where you buy a property that is expected to produce above-average increases in property value over time. These properties are typically found in capital cities, major regional centres or areas under development.
They also often have a higher purchase price and lower rental yield. This makes them negatively geared, which means the annual cost of your investment is more than the investment property rate of return.
- Potential to generate long-term capital growth, as the property value increases over time
- Tax benefits or deductions may be claimed for some of the out-of-pocket expenses or losses
- As your investmet property value increases you may be able to draw out equity or borrow against it to expand your investment property portfolio.
- You will need to dip into your salary or savings to cover the difference between the rental return and your property expenses
- The property needs time to accumulate value, so any financial return on investment property is only realised when the property is eventually sold
- When you sell you may be charged capital gains tax, which is tax payable on the profit you’ve made on the investment property, which will impact your overall gain
- These investment properties are typically more expensive to buy and are in higher demand.
Property investment for rental return
Also called a cash flow investment strategy, the rental return approach is where you’re buying an investment property that will deliver a strong rental return through high rents. A rental return investment strategy could also suit you if you have a home and you’re weighing up leasing vs selling, because you’ll still have cash flow to rent or buy another home for yourself.
These properties are more often found in regional or outer suburban areas where rental demand is strong. These properties are also positively geared – the income you receive more than covers expenses such as the mortgage, strata fees, insurance or other related costs (which is why it could work for leasing vs selling).
- You generate income off your investment property because the rent received is higher than your expenses
- Your investment property pays for itself, so you’re not out of pocket (excluding initial costs such as deposit, legal fees and so on)
- Excess rent may be used to pay off your loan sooner, act as income for retirement or you can reinvest it
- You’re cash flow positive, so lenders may be more inclined to loan to you again so you can continue to build your investment property portfolio.
- Tax may be payable on excess rental income, which would minimise the net return
- Capital growth is likely to be lower than a property purchased for long-term growth potential
- As interest rates increase, your rental return will decrease.
With both investment strategies, whether you’re investing in commercial property or residential property you will still be responsible for finding good tenants, handling maintenance requests and emergency property maintenance.
Determining which investment strategy – capital growth or rental return – is the smarter approach isn’t clear-cut. Different personal and financial circumstances and objectives will naturally lead investors towards a specific strategy, e.g. can you afford to be cash negative or out of pocket, or do you need the income from your investment property to cover your costs or potentially even generate an income?
Before entering into any investment it’s best to seek expert financial advice. You can find out more in Aussie’s free downloadable Property Investing Guide.
Have you recently bought an investment property? Which investment strategy did you choose and why? Share your experience in the comments!
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