Do you know your capitals? Are you in the know about cash-flow?
Anyone planning to enter the property market will benefit from knowing the difference between capital gain, capital value growth (appreciation) and cash-flow.
These are the financial equations that underpin every investment in rental bricks and mortar.
Know the difference
Anna Kyriacou, Principal at AKA Group Accountants Advisors Mentors, explains the difference between capital gain and capital value growth/appreciation:
“A capital gain is the profit an investor makes after selling the property, whereas capital appreciation (value growth) is an increase in value of property while you still own it,” she says.
Capital gain is the profit an investor makes after deducting the initial costs of property purchase and associated selling costs and it is taxable.
“In basic terms, a capital gain equals selling price minus purchase cost minus associated costs with purchase and sale,” Kyriacou says.
Capital value growth may occur if a home’s amenity is improved with renovations or extensions.
Capital gain is the selling price minus purchase and associated costs.
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It also happens when you buy a home in a suburb that later records property value growth because of a shortage of homes and/or strong demand from buyers.
When either of these things happen your property’s “paper” capital value grows.
“As long as you don’t sell your property or have a capital gain tax event, you won’t be asked to pay taxes on your capital growth,” explains Juliana Ardila, Owner of Prada Credit Solutions.
Ownership rewards:What are the benefits of buying your own home?
What is cash-flow?
Cash-flow is what is left in an investor’s pocket once all regular ongoing costs are deducted from all regular income (rent).
Cash-flow is what’s left to an investor after all ongoing costs are deducted.
Again, in simple terms, from a tax point of view cash flow is gross rental income less property expenses less loan repayments plus any tax benefits, Kyriacou says.
It should be noted that in many Australian suburbs property prices are rising quicker than rents and so investment homes are commonly producing “negative cash-flow” for their owners.
Negative cash-flow is a shortfall between the property’s weekly/monthly cash-flow and its loan repayments.
Investor question:Should I sell or lease out my property?
What should I look for?
So which factor is most important when selecting a rental property?
If someone is starting an investment portfolio, they need to look at cash-flow and capital appreciation.
“If someone is looking to start an investment portfolio, they need to look at both cash-flow and capital appreciation/gains as it would really depend on the individual investors goals,” Kyriacou says.
“If, for example, the plan is to hold and pass property to next generation, then cash-flow is going to be more critical than capital gains, but if the plan is to buy and keep buying investment properties it will require both cash-flow and capital gains/equity growth as you tend to use the equity in one property to use as deposit for next.
“My recommendation is to always chase both, as what is the point of having an asset that does not have cash-flow and is increasing in value each year. If it does not have both, in my view, it is simply going to be a money pit, as houses require maintenance and in some states $1,000s of dollars in land tax (when selling).”
Simon Cohen, Managing Director of buyer’s agency Cohen Handler agrees.
An investor’s goal should be about “finding a happy medium” between capital value growth, and regular cash flow.
“It is about doing your research and finding a property that has that right balance for your own individual needs and goals,” Cohen says.
“Most importantly, it must be in an area that is rentable. That is essential, because you do need rental cash flow to help you cover ongoing costs associated with the property and you are not out of pocket too much if at all, from week to week.
“It also means you are less likely to need to sell before you are can reap the full benefit of long-term capital gain.
“I personally buy properties that can be tarted up because if you can create some capital value growth for yourself – above and beyond the general market rising – well, that is even better.”
Find more advice in our Investing guide
This article was originally published on 26 Mar 2015 at 10:00am but has been regularly updated to keep the information current.
