Many people want to build a property portfolio in the hopes that one day, they can sit back and live off the cash flow.
While this is a nice idea, I think these people are looking at property the wrong way.
Property is about growth, not cash flow. And there are plenty of very wealthy people out there who will tell you the same thing.
When we look at the potential cash flow that a property generates, we will typically see rental yields somewhere between 2 to 6 per cent depending on what you’re buying. If you are buying a property in a regional area, you might get a high yield. Something more blue chip will be a lot lower.
While those yields are fine, they do not include all the costs that come along with holding a property. As a property owner, you will need to pay council rates, water, maintenance, property management fees, and potentially land taxes or strata fees depending on what and where you buy.
These costs quickly add up and you can find yourself paying 2-3 per cent every year just to hold onto the property. If you own a property with a low yield, even without any debt, you could well find yourself just breaking even from a cash flow perspective.
On the flip side, the growth side of property is very appealing. The fact that property increases in value by around 7 per cent per year is in itself very impressive. As an investor, if you can simply beat the average, you are going to be doing very well for yourself.
However, the most powerful part of property is the fact that you can get so much leverage. You are able to put down 20 per cent or less and that means the return on your cash is extremely high. That makes the growth equation even better.
On top of that, you also have the ability to add value to the property. This is typically done through renovations or even small-scale property developments or subdivisions. What you’re doing here is effectively manufacturing growth regardless of what is happening in the market.
By adding value, you can get even more growth and you can achieve it in just a few months.
Over time, you will find that the compounding nature of real estate will see the value of your property grow and grow. The overall returns will be far greater than the small amount of cash you might be generating every month from rent.
In time, if you do need cash to live off, you have the option of either selling down a property or drawing out equity. What’s even better is that if you draw out equity, you’re not paying any tax on it. Unlike when you receive rental income each month.
The growth is also the thing that helps you build a large portfolio in the first place. While cash flow certainly helps with serviceability, it is growth that makes the big difference to your portfolio’s value.
So when you start planning for your next property purchase, stop thinking short-term about how much rental income you might be making. Think about what the value of that property is going to look like in 10 or 20 years.
Or even better, think about how you can use the equity uplift from buying a high-quality property to purchase your next one in the next few years.
