Do I invest for Cash Flow or to Grow my Portfolio ?

WHICH IS BETTER, CASH FLOW or CAPITAL GROWTH???

There has been a war going on out there between the two camps of property experts since day one of property investment:

Cash Flow vs Capital Gain.

According to the law of nature "anything that doesn't serve a purpose will cease to exist".

The fact that we have enough people arguing about the two clearly indicates that they both still exist, and hence serve a purpose!

LET'S START WITH SOME ARGUMENTS IN FAVOUR OF THE CAPITAL GAIN:
I have done some careful analysis over a 20 year period of purchasing the same amount of properties in Cash Flow and Capital Gain categories. Here are the parameters I've included in my calculations:

· No borrowings, so there is no negative gearing benefit in the picture;

· Surplus cash flow after paying tax will be reinvested to get a 10% per annum return;

· Every time we have surplus cash flow, either through rent or re-investment, we'll be paying 30% income tax (assuming the investor is of average income);

· Net Worth is calculated assuming Capital Gain Tax and Income Tax are both paid.

Year Capital Gain Property Cash Flow Property Growth Rent Net Worth Growth Rent Net Worth 10% 4% 4% 10% 1 $300,000 $12,000 $308,400 $300,000 $30,000 $321,000 2 $330,000 $13,200 $336,708 $312,000 $31,200 $346,410 3 $363,000 $14,520 $375,809 $324,480 $32,448 $372,789 4 $399,300 $15,972 $412,725 $337,459 $33,746 $395,488 5 $439,230 $17,569 $452,450 $350,958 $35,096 $416,890 6 $483,153 $19,326 $495,469 $364,996 $36,500 $437,450 7 $531,468 $21,259 $542,267 $379,596 $37,960 $457,524 8 $584,615 $23,385 $593,341 $394,780 $39,478 $477,396 9 $643,077 $25,723 $649,214 $410,571 $41,057 $497,286 10 $707,384 $28,295 $710,434 $426,994 $42,699 $517,376 11 $778,123 $31,125 $777,593 $444,073 $44,407 $537,810 12 $855,935 $34,237 $851,326 $461,836 $46,184 $558,707 13 $941,529 $37,661 $932,324 $480,310 $48,031 $580,167 14 $1,035,681 $41,427 $1,021,337 $499,522 $49,952 $602,276 15 $1,139,250 $45,570 $1,119,187 $519,503 $51,950 $625,108 16 $1,253,174 $50,127 $1,226,773 $540,283 $54,028 $648,729 17 $1,378,492 $55,140 $1,345,078 $561,894 $56,189 $673,199 18 $1,516,341 $60,654 $1,475,185 $584,370 $58,437 $698,574 19 $1,667,975 $66,719 $1,618,279 $607,745 $60,774 $724,907 20 $1,834,773 $73,391 $1,775,666 $632,055 $63,205 $752,250

It's obvious that a typical Capital Gain property will build more net worth for an investor than a typical Cash Flow property after a few years of holding.

There are two more parameters that can also affect the picture here:

· Tax benefit's: if the investor decided to borrow enough finance so that the interest repayment is higher than the rental income (for Capital Gain property), then the investor gets a subsidy (called negative gearing benefit) from the tax man, and it will make the Capital Gain property category look even more attractive in terms of net worth building.

· Finance: to be able to purchase more properties, you need to have equity. Capital gain properties generate equity faster, although some parts of it will be Capital Gain Tax when the property is sold, until then; the investor is free to use the equity to purchase the next property.

Some people might say that you need income to service debt, if you keep building net worth with little income, how can you borrow more money?

The answer is that "high net worth individuals never have a problem borrowing money", there are lenders that will lend you the money as long as you have asset (called asset lend or equity based lending). Think of it this way: if your future income (you think you might still have) can service debt, why can't you mentally put aside a lump sum of money (you definitely know you already have as part of your net worth) from the beginning to service debt?

Some property investors argue that how can an asset increase in value if there is little cash flow? There are plenty of investments that don't generate a cash flow but increase in value, such as painting, vacant block of land, etc.

Why is the cash flow of an asset is not necessarily linked to the value of the asset? The majority of the Australian home owners purchase residential properties to live in, not to generate a cash flow and property investors are taking a ride with the home owners as the home owners predominately drive up the value of residential properties due to the scarcity of land.

It's very obvious that Capital Gain properties rely on Capital Gain, the strategy wouldn't work if you select properties with no future growth. Although well selected residential properties have demonstrated an average 10% compound growth in the last few decades through a few property cycles, it still doesn't seem to convince some investors that well selected properties will continue their historical performance. For most people, the threat of the disaster seems to be more real than the disaster itself.

Asset selection experience, mature investment psychology, reasonable financial resources and discipline are required to execute this strategy. In other words, this strategy is not for the majority.

SO WHAT'S GOOD ABOUT CASH FLOW PROPERTY THEN?

Cash flow property puts money in your pocket from day one! The feeling of making some money sometimes is more important than the actual amount you're making.

I have experienced first hand a lot of property investors just couldn't comprehend that losing cash flow can build more net worth in longer term, some would argue that the capital gain might never come, money in my pocket today, as little as it might be, is better than tomorrow.

Cash Flow properties sometimes can have tremendous capital gain as well; some investors naively believe that some assets can forever enjoy both high yield and high capital gain. Due to a long period of underperformance in some area, some of the cash flow properties have exceptionally high yield (>12% for the current market), the scarcity of the high yield (not the land) can drive the value up temporarily due to strong demand, until the yield becomes average again, then the capital gain will be slow just like any other Cash Flow properties.

Many people would like to invest in Cash Flow properties, the main reasons are:

· Concern that capital gain might never be there - I will at least hang on to my cash flow;

· Lack of sufficient finance resource to cover negative cash flow for a few years until it turns neutral;

· The thought of negative cash flow makes me sick - I might not live to enjoy my wealth;

· Believe only income can service debt - can't get used to the idea of debt servicing debt;

· I feel good about seeing some money coming in at the end of each month - that feeling means more money than the money I actually make;

· I just want to have passive income, what's the good of high net worth? - don't believe that there are ways net worth can be converted into cash flow;

· I want to get in Cash Flow properties while the yield is exceptionally high, and hopefully enough people will come to the area to buy up the price (not hard to do for a small town:), so that I can get out with my Capital Gain. In other words, I'm using Cash Flow as an illusion to make my Capital Gain!

Anyone with the above psychology and financial position really has two options: one is to invest in Cash Flow property, the other is not to invest at all. Capital Gain property is definitely not suitable for them.

Cash Flow properties have lower risk, but also lower return, this strategy has a much wider appeal to the general investors market. It doesn't take much knowledge & psychology to interpret the rental income, as long as you don't buy properties that will need a lot of repairs, you can comfortably enjoy the cash flow every month.

CONCLUSION:
We all started investing for getting passive income that we can retire on one day, building immediate cash flow is an obvious way to get there, and building net worth first is just another less obvious way for some that are ready for it.

It is not which strategy that is better between Cash Flow and Capital Gain; it's which strategy fits your current psychology & financial position the best.

Cash Flow property camp is always much bigger than the Capital Gain camp, much the same as there are more students in high schools than universities. For the teachers (experts in each camp), there is absolutely nothing wrong with people going to high school first before they go to university, there is also absolutely nothing wrong with some people that may never want to go to university and still live a fulfilled and happy life. As a matter of fact, people don't even have to go to high school if they don't want to (although highly recommended)! It is also common sense to know that it takes very different skills to teach high school and university,

they are both challenging jobs if you want to get it right.

On the right hand side is the property hierarchy, the higher you go, the higher risk you take, and hence the potential higher return which also requires better financial position, more experience and more mature psychology, etc.

For the investor readers: your best strategy is always the one that is suitable for your current situation. Your strategy should change according to your current situation.

Here is my two cents for all the participating experts in the two camps: even if you agree with me that there is no need to take side anymore, you can accept the other camp a lot better now. I would then suggest you take one side that you're most comfortable with, and pretend to fight the other side like you really mean it.

Here is why: the fact that you believe in something so strongly can influence people around you, and it will make you a leader in something. Most people follow someone who has the strongest belief, sometimes it doesn't even matter what that belief is, and you will always have an equal number of people support and challenge you on everything you do anyway.

At the end of the day, Right and Wrong are the labels we put on things based on our own value systems. We may all have different value systems, but no one has "better" value systems. Hence there is no right or wrong in any anything you do, you might as well pick something you would do with passion, at least that way you feel like you live for something!

Life is really like a game, you almost have to take side if you really want to play, as long as you remember that you are the one who created the game in the first place, and then you won't take winning or losing too personally.

I've been asked many times before: "Which side do you take - Capital Gain or Cash Flow?" What a silly question! Of course I'm on your side!

This article was contributed by Bill Zheng, Principal of Investors Direct Financial Group.

What is a Buyer's Agent and can they help me?

Imagine having a real estate agent working for you when you want to buy real estate.

Wow ! ! !

This is a bit of information about how Buyer’s Agents work.

With the property boom long gone we are now in a much fractured property market for both investors and owner occupiers and there are only a few good buying opportunities available. The market has many secondary properties for sale, purchased in the boom and now, with some investors unable to hold their entire portfolio, back on the market and being touted by less than scrupulous sellers as prime stock.

Finding those good opportunities is an increasingly difficult and consuming task for the average person.

We are seeing a markedly increasing trend for buyers to enlist the help of a Licensed Buyer’s Agent to represent them and advise and assist them with their purchase. In some countries it is the normal thing to do and in some US states it’s mandatory.

We aren’t quite there yet but it is a trend continuing to gather strength.

To help investors make sensible investment decisions various leading property commentator s were canvassed and voiced their thoughts about using a Licensed Buyer’s Agent in this very fractured property market.

Doesn’t everybody know how to buy a good property?

According to Michael Yardney “In the current market investors can’t just buy any property and expect it to increase in value like they did in the boom times. Buyers need to do their research more carefully than ever. To buy a top performing investment property, investors will need to buy the right type of property — those with great upside potential.”

As an investor, if you’re looking for the magic mixture of capital growth and strong rental returns, as long as you buy the right type of property at the right price, you will achieve it.

Capital growth will come from a good mix of demand from both investors and owner occupiers, tightly coupled with limited supply of the type of property desired. Strong rental signifies demand from tenants in a limited rental market. The two elements are both critical to success.

“The Valuer General’s Department regularly releases statistics of historic property growth. Some areas have shown property values to have grown by up to 400% during the last decade. But Other areas have shown property values to have grown by less than 50%. That means if you bought a $100,000 property 10 years ago in some of the better areas it would be worth between $300,000—$400,000 today, while in other areas it may only been worth $150,000. Further, it seems from these reports that the price of some inner city units have actually fallen over the last ten years.”

These properties will always continue to increase in value due to the coupling of demand with scarcity.

As an owner occupier, looking for that perfect dwelling, the road to success is tortuous and difficult, but if you have the time and patience it will eventually come along. Then when you find it there are usually repairs and renovations to get involved in and

The question you must ask yourself is “do I have the time, energy, patience, skills and knowledge to succeed in this difficult market?”

Of course that doesn’t mean you can buy any property in good suburbs and expect it to go up in value? Finding properties with the potential to out perform the general property market requires some high level experiential property knowledge, firstly knowing the areas that have had the highest capital growth in the past, districts within those areas that perform better than other and streets within those districts and even down to individual properties within those streets.

Some suburbs just seem to out perform others consistently. Then within those suburbs there are the right areas, the right localities, the right streets. Some streets always out perform others. Within those streets one must then find the right properties. Some properties have more appeal than others. Some floor plans are efficient while others are disasters.

These days, in this market the astute investor manufactures their own growth by adding value to the property; usually by renovation or redevelopment or by some variation with title. It is true to say that some properties have great potential for adding value through renovation and others don’t.

There are many detailed laws to redeveloping a site for medium density housing and only the expert can wend their way through these complex awes and regulations by councils and State Government; not infrequently in direct competition with each other. Would the lay person know which property has good renovation potential? Which one has the possibility for growth through value adding or is a site that may be possibly appropriate for a development. Probably not !!!

Still the question must be “do I have the time, energy, patience, skills and knowledge to find that particular property in this difficult market? What is the risk of and penalties for failure”

Selling Agents who may appear to working for you, the buyer, and they’ll certainly tell you or indicate that they are on your side, are legally required to work in the best interest of the vendor. The legislation is very clear in this area. Their obligations are to the vendor in each and every case.

A good selling agent is legally obliged to get the buyer to pay the highest price to the vendor for the property. That’s their job. They are not obligated to provide you with all the relevant information about your purchase other than as is required by law in the Vendor’s Statement. While there are strict laws of disclosure, the property market revolves around a very strongly structured “buyer beware” caveat.

Would you really expect a good selling agent to tell you about his knowledge of the market unless it feeds his position, that there are better properties available for sale with another agent or about comparable properties for sale at lower asking prices in the same suburb/district? Is the agent obliged to remind you that you should carry out building, termite or pest inspections?

Remember who they are working for.

There is an increasing trend for investors to use Licensed Buyer’s Agents (or Advocates) to help them find good properties. Buyer’s Agents have levelled the playing field; as a busy, inexperienced purchaser it is tremendous to have an agent in your corner working for you the buyer, rather than for the seller.

”Many first time investors end up having a negative experience because they have over-committed themselves, succumbed to the “hard sell” that often accompanies low capital growth, speculative property, been tempted to ride a perceived property “boom,” or thought that any property would make a good investment” states Richard Wakelin..” Don’t start your property investment journey alone! “

A good Licensed Buyer’s Agent will have access to every property for sale through every agent in the areas they work and will advise a purchaser what searches and checks are required when they consider buying a property. They aren’t limited to any area, to any particular style of property and, importantly, are not restricted in any way as to what a serious buyer may direct them to find.

Experienced Licensed Buyers Agents are out in the market place all day searching for properties on behalf of their clients. It seems in the inner suburbs, at every auction there are a number of Buyers Agents bidding, and usually winning, because of their expertise and experience.

Frank Valentic points out “We search for a property meeting your criteria and requirements, doing all the legwork for you. Once we have found your preferred property, we will represent you at auction or through private sale negotiations.

Using our expertise and full sales data, we evaluate the property's value. We assist in all areas of the purchase right through to settlement. “

There are reports that some of the better Buyers Agents, while attending at many, many actions, finally bid on very small percentages of the properties they research. Further, apparently while these Agents only end up purchasing a little over half of the properties they bid for. The rest are bid up to a price considered too expensive to buy, yet other people still buy those properties. Go figure.

“When confidentiality is important, we respect this”, Janet Spencer makes the point.

“If you will be borrowing funds, it is important to have your finance approved in principal by a lending institution prior to committing to a property. We can refer you to experienced bankers and mortgage brokers who will assist.

We often recommend a building inspection prior to buying targeted property. Better safe than sorry. Unplanned for building repairs and maintenance can really negatively affect your bank balance.

Investors will be referred to a reputable and experienced Property Management specialist. We follow up on this relationship and also the letting history of your investment. Prior to buying we provide independent rental assessments for investors.”

How to choose a Buyer’s Agent

If a buyer is unsure of the expertise of any particular Licensed Buyer’s Agent, they should enquire about their experience, i.e. how many properties they have purchased (this year, last year etc), where they have purchased and what styles of property.

Other questions will include whether they work predominately for owner occupiers or investors and how good a negotiator they are.

Ask them if they really know the different between a stratum title, a strata title or a company share title and which is more preferable and which has got good upside potential?

Ask if they really understand the difference between an overlay, a covenant and an easement. Which can they build on and which can’t they?

Ask what permits are necessary for a full renovation and who to work with to obtain them.

You might be surprised.

In some countries most transactions are conducted with both a buyer’s and seller’s agent.

Why wouldn’t you go into a real estate negotiation without a buyer’s agent on your side?

Now that there are new regulations outlawing dummy bidding, is it safe to buy at auction?

Yardney states, “I have bought some real bargains at auction, but there are many traps to watch out for. A good auctioneer will have conducted thousands of auctions, but this is may be the buyer’s second or third. A good auctioneer can read body language. They easily recognise a nervous purchaser and control the auction and apply pressure to the advantage of the seller.”

“Auctions are exciting” Melissa Opie says, “but they can also be difficult to negotiate. We are experts in this field and as such, will bid on your behalf come auction day. The Auction Representation Package has been developed for clients that are ready to purchase and require a skilled and experienced Advocate for auction attendance, bidding and post auction negotiation.

Having a professional Advocate acting on your behalf keeps your identity confidential. Vendor’s Agents generally recognise potential buyers from property inspections and as a result often have prior knowledge of their spending capacity and desire to buy.“

According to Yardney “Unless the purchaser is very confident, I would recommend that they get an experienced friend or a good buyer’s agent to bid on their behalf. This could save thousands and thousands of dollars.”

There are also many different elements to buying through private sale rather than at an auction.

The important thing to remember about a seller’s agent is that their job is not really selling property, it is really about listing property for sale, a most competitive task that should require at least 80% of the agents working time.

In reality the property will always sell, if the vendor is a fair dinkum seller. There may be some

“to-ing and fro-ing” about price, terms and conditions but the property will always sell. Hopefully by the selling agent who lists the property for sale, if not by one of his colleagues; and he will still get paid. The small percentage that doesn’t get sold by an agency will mostly eventually go to another agency and most probably a similar number of failed sales will accrue to the first agency.

If the agent lists a property and can have it sold shortly thereafter, then they can spend more time listing and building their business. The smarter agents realise that a good, active Licensed Buyer’s Agent will have a string of clients for whom they’re searching for good property.

By contacting their “A“ list of Buyer’s Agents at the listing stage, they may have the sale done and dusted before the property goes on the market, thus not requiring hours and hours of the agents time at open house and many, many private inspections.

The vendor is usually happier foregoing a long and stressful sales campaign, often resulting in a failed auction or with angst and annoyance from the extended inspection process, especially from the tenant in an investment property sale. The buyer will not have to face the worry of competition in the extended sale or auction program, and may achieve the best possible purchase price or conditions, and both agents will have achieved satisfied clients from the process.

Alternatively there are many arguments to support the purchase of property by auction

It may be of surprise, but not all offers are submitted to the vendor. Think about what may happen if you make the same offer as another buyer, but they have a property for the agent to sell and you don’t because you’re not selling your home; you are buying an investment. Or what may happen if you make a great offer on the first weekend of the marketing campaign. Or you are not dealing with the listing agent who controls the sale.

You’re not in a good position, are you?

Do you have any other suggestions?

Yardney says, “Investors should remember that they make their money when they purchase their property and there are 3 key elements to buying well.

Timing is important—try and invest counter cyclically— good buys are available during the late slump and upturn stage of the property cycle. These are buyer’s markets rather than the frantic seller’s markets of the property boom.

It is critical that investors never over pay. They need to understand fair market value to ensure they buy well.

And the property you buy should have strong growth potential. I talk about buying ‘properties with a twist’ ….properties where we see opportunities that others don’t. I like properties where you can add value through renovation or getting development approval for multiple dwellings.

To get more information about how a Licensed Buyer’s Agent could help you choose a top performing investment property that will outperform the market, log onto their website or post a comment on this blog. Your interest will be rewarded.

Best wishes

Jack Henderson

(Many thanks to Richard Wakelin of Wakelin Property Advisory, Michael Yardney of Metropole, Janet Spenser of Buyers Solutions, Frank Valentic of Advantage and Karin Mackay of Australia Property Buyers for their comments and extracts).