Is It Capital Growth Or Rental Income That Will Make You Rich?
Posted by Jacques Fouché (28 September 2017)
“Jacques, what is more important: capital growth or rental income?”
Whilst it is sometimes possible to have both strong capital growth and a high rental income generating property, it is highly unusual to get both on the same property. Rental yields on a high capital growth property are normally lower than the rental yield on a lower capital growth property.
Ultimately you have to choose between the two, but which one do you choose?
Well, the first thing to assess is your own cash flow, your investment strategy and your unique financial situation according your real estate investment plan goals. These factors will determine whether it’s going to be rental-yield-focused or a capital growth decision.
I have been in the privileged position to coach, train and mentor literally tens of thousands of real estate investors over my career. And I have never seen an investor become wealthy when they chose to focus on buying cash flow properties. One of the biggest reasons investors never become financially free is they invest solely for cash flow instead of capital growth.
The truth is, it’s really hard to grow your wealth with cash flow. You cannot save your self rich with rental income. And rental income (profit) is taxable while capital growth is not.
When you are a real estate investor you will need save up deposits for your next property purchase. So, where is that deposit going to come from? From your rental income every month? To save a few hundred rand a month from a positive cash flow property is not going to build up adequate cash flow for that next deposit. You are going to wait a very long time – it’s highly unlikely that Investors can save multiple deposits over their lifetimes if they only focus on high yielding and income-generating properties.
But what you can do is use the capital growth, or equity, in your properties for the deposit on your next deal. If you’d invested in cash flow properties only you’d have solid rent coming in, but like I said: it won’t do much to help you with a deposit for your next investment property.
And if I have heard the following statement 10 000 times I am not exaggerating: “Jacques, capital growth is only a bonus.”
Only a bonus? Capital growth is almost everything! That is how you become wealthy. That’s like saying it’s a bonus if you can become financially free. The way we become financially free should be a well-executed, purposeful, strategic plan for any real estate investor. And that plan must include high capital growth properties in high growth areas.
I have seen this movie so many times… cash flow-focused investors would rather buy a R100 per month positive cash flow property (on which they have to pay 40 to 45% tax) with no potential upside of capital growth, rather than buying a property that has a monthly shortfall of R1 000 but that has the potential of long-term sustainable capital growth.
Investors feel that they are making a loss. But are you making a loss, or are you temporarily advancing a loan to your business until it reaches the breakeven point, while building real equity through the sustainable capital growth? Or you can see the R1 000 shortfall as an investment that will be the worst it will probably ever be in the first year, and will only get better moving forward, because you will increase the rent you charge annually.
Investors loose sight of the bigger 5, 10 and 20 year property pictures.
Paying a small shortfall —is an investment if it’s the right property.
Always remember, this is a marathon not sprint. Force yourself to see the bigger picture and do your calculations.
Income growth escalated per year is escalating from a very small value base. Capital growth escalates from a very big base, namely the value of the property.
Let’s say you buy a property to the value of a million rand. Let’s use an assumption of 8% growth per annum on rental income and 8% on capital growth.
The capital growth appreciation of 8% is on a much larger amount as it is based on R1 000 000.
The rental income growth escalation of 8% is on a much smaller value. For example:
8% on R7 500 = R600 per month x 12 months = R7200 for the year additional growth.
Whereas, 8% capital growth on a million rand asset = R80 000 capital appreciation for the year additional .
When you focus on building your asset base you will trigger the compounded capital growth effect. This will allow you to create the equity, which allows you to create cash flow for your next deposit to buy your next investment property. And if you do this strategically, you build your asset base tax free until retirement while using the receiver as your business partner to help you achieve financial freedom.
This asset base needs to create equity, which is what we are after as real estate investors.
What creates equity? Well, you guessed right: capital growth.
The secret is to get your first investment and then the second investment and then third etc, and one property will compound on top of another, which will create equity fast.
I always say capital growth gets you out of rat race, cash flow looks after the asset.
You can’t save your way to wealth.
The wealthy think about building assets and the average investor thinks cash flow.
Once you reach the age of retirement you will be strategically converting your equity or capital to create a passive cash flow income stream at retirement.
Assets create real wealth – as your assets grow your income will flow from them as you transition into retirement.
You can achieve financial freedom. This is for the average person, the normal guy and girl and the average salary earner – not just for the rich. Financial freedom is also for the ordinary South African. The ordinary income earner that truly believes in their dreams of living life to its full potential.
Go out there every day, invest strategically, invest intelligently, become financially free and leave a legacy.
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