Thursday, 31 May 2012

Why Invest in Property? Part 1: Capital versus Cash Flow

The creation of independent wealth and the use of the style of money called capital are not widely taught to aspiring Australians, most of us need to find out for ourselves.

Many so-called property investment advisors are teaching part of the story to engage people to buy their properties. However we would like you to know a little more so you can decide how to apply the knowledge to your property investment considerations; whether you plan to retire early or want to create a dynastic family trust.

 

When we look at large businesses, and by analogy you are creating a small property business to manage in your retirement, they have two styles of money. They use the style called capital to create more money, and the style called cash flow to fund daily activities. Their ‘rules’ and use of these two styles of money are quite different. Cash flow is budgeted each year and consumed to fuel business growth and profit. Part of the profit is then reinvested in the business and part is preserved as capital.

 

When we create capital it needs to work hard for us to bring more wealth. It is our capital backing that gives us more choices and more business opportunities.


Many of us are salaried employees and some of us use our total salaries as cash flow. This is rarely sustainable into our retirement unless we have a very generous superannuation scheme via our employer or inherit capital from our families. Some of us have a savings plan and this is a form of preservation of money that may become capital. However many of us save to buy holidays that are part of our cash flow or new cars that are depreciating assets; over time they become less valuable.

 

Capital needs to buy appreciating assets, things that increase in value over time. Typically we might consider shares, though many Australian’s lack a strong understanding of the share market to have confidence they can do well. Also the market has been very volatile recently threatening our capital through losses. Most of us do not feel comfortable with this volatility, as we do not have time to micro manage our investments.

 

Property has historically increased in value over time and banks have been willing to lend up to 90% of the value to investors. This leveraging of capital with the addition of the bank loan gives you the ability to gain higher returns.

 

Example 

  

 

Apartment in Trilogi in Prahran
 

 

 

Your capital investment though equity release or savings

   

$41,000

Bank loan

 

$369,000 

Total Value

 

 $410,000

  

 

 

 Potential returns at 6.5% capital growth per annum
 

 

 

 Year 1

 

 $26,650

 New Value

 

 $436,000

  

  

  

 Year2

  

$28,380 

 New Value

 

 $465,000

  

 

  

 

Our $41,000 capital is earning about 65% return per annum and the cash flow requirements before your personal income taxation rate is applied are $100 per week or $5,000 per annum to hold the property. Over time and with a number of properties this can create substantial capital and the opportunity to convert this into cash flow to fund retirement life choices.

 

Talk to your qualified property investment advisor to learn more.

 

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