You have probably heard that there are generally two types of residential property investment strategies:
- Passive strategies
- Active strategies
This is where investor puts in a standard amount of effort and therefore the investment has a standard risk profile and standard return. They also typically require a normal deposit (5% – 20%) and normal finance (95% – 80%), they receive natural capital growth (3%-10%) and a natural yield (2.5% – 8%). These types of strategies include:
- Cash Flow vs. Growth
- Houses vs. Apartments
- New vs. Old
- High price vs. low price
- Special purpose
This is whereby the investors puts in more effort on a more “creative” type of opportunity, which typically has a higher risk profile and return. These strategies usually involve a creative deposit (5%) and a creative finance solution (>97%). The rewards for this extra effort are instant capital growth (5%-25%) and higher yield (>8%). These types of strategies include:
- Small Development
In the coming weeks, I will be discussing the upsides and downsides of each strategy.
Let’s start with strategy #1 Cash Flow Properties.
There are properties with a low capital growth profile of 4-6% and high rental return of around 6 -10%. Occasionally though the capital growth achieved for these types of properties can be very high, however it’s usually not sustainable.
The main advantage with cash flow properties is the positive or neutral cash flow that they generate. Typically, these properties are located in regional areas and so they tend have lower entry prices (as well as lower stamp duty and land tax). Therefore, for investors who don’t have much equity or income it is easy to get started. Moreover, you can use the surplus cash flow to reduce the debt more quickly to release more equity for future investment.
Secondly, because of the popularity of these types of properties, it is not uncommon to occasionally achieve strong capital growth gains due to the demand for high yield properties depending on the economic climate at the time.
From a finance perspective, the income generated from the asset manes it is easier to get a loan with a higher loan to value ratio. i.e. you can borrow more (thereby putting in less of your own money).
First, because you are generating an income from the positive cash flow, you pay tax along the way. You are taxed on this extra income and money in the taxman’s pocket is going to make it hard for you to create serious wealth.
Secondly, these properties are usually in regional or outer areas they can be quite sensitive to economic cycles and that is why compared to properties located closer to the centre of our major cities, they will generate lower capital growth over longer term.
There are also potential higher costs associated with maintenance and more tenancy problems due to socio-economic factors.
Finally, from a finance perspective, it is harder to get loans for some regional properties due to postcode restrictions imposed by lenders, mostly due to their smaller populations. The result is lower leverage, which in turn requires more deposit from you and reduces your return.
Elmer Liu is a senior mortgage strategist at Investors Mortgage. He is also an active property investor passionate about achieving financial security via property and helping other IT professionals to achieve the same goal.