Advice and Opinion

The pros and cons of growth versus cash flow on property

Just back from another visit to Australia, Bill Rawson, Chairman of the Rawson Property Group, reports that to his surprise in the Australian property media, the pros and cons of capital growth versus cash flow on property is still being debated at length.

“I thought that the last word on this subject had been said some time ago because of course there is usually a high connection between good rentals and capital appreciation. If you achieve good rentals you will usually also get significant capital appreciation and vice versa. However, those interviewed in the Australian property press made many points that are as relevant in South Africa as they are to Australia.”

Those backing capital growth, said Rawson, argue (to quote an article in the Australian Property Investor) that genuine wealth is achieved when the value of your assets double in every growth cycle. These, as in South Africa, usually cover time periods of seven to ten years, but in some cases they can be as short as five years.

To achieve this very valuable doubling, the rental income has to be supplemented by significant capital appreciation.

Most people agree that new property in general appreciates faster than old property and this outlook in South Africa and Australia is encouraged by certain tax allowances on new property.

Several investors interviewed, said Rawson, tipped the CBD peripheral sectional title properties as likely to offer the best opportunities for growth, particularly if they are close to public transport and good facilities such as schools and retail complexes.

“It is noteworthy that most advised avoiding the really luxurious top priced properties in favour of the medium priced units. We have found the same approach tends to work in South Africa.

“One investor, Cam McLellan, who invests almost exclusively in residential property in Perth, Brisbane, Sydney and Melbourne, was quoted as saying that his researchers always begin with the elimination of markets that common sense indicates are not as well positioned as they might be or have been performing so well that they may well be nearing the overvaluation stage.

“McLellan says that he then waits for a stagnation or even a downturn period in the property market before buying. The adverse conditions at these times make it possible to obtain a good price as there is less competition.”

“Later when the property market does begin to show real signs of life he may liquidate some of his equity and buy again in the lower price brackets.”

“This advice is quite clearly sound, but it is worth commenting that in South Africa many new projects continue to show significant capital appreciation five, ten or more years after their completion – to the surprise of those who still stick firmly to bubble burst philosophies.”

One of those promoting the income earning potential as a priority defined it as “achieving a rental yield that is well above current interest rates” – in Rawson’s opinion a worthwhile definition – but the same spokesman warned that mediocre investments will often continue to perform badly in perpetuity or if revived in some way or other may take anything up five years to give the same sort of returns as a good investment.

Most of those quoted in the Australian Property Investor also, said Rawson, conceded that once good rentals are achieved, capital appreciation tends to follow – which has also been his experience.

While virtually all those quoted advocated continual on-going buying of property stock, provided the investor has reserves to ride out bad periods, many warned against overextending oneself in this field. Jessica Darnbrough of Mortgage Choices said that overextending in boom periods is probably the biggest mistake that investors make.

Concluding his comments, Rawson said that it was quite apparent from the comments made by those interviewed that to achieve their goals they had all had to take fairly tough lifestyle austerity measures.

“The message coming through loud and clear from these successful entrepreneurs,” said Rawson, “is that sacrifices will initially be necessary – but in the long term they will be very well worth making.”