Capital Growth Or Rental Yield
Property remains one of the most popular investment assets in Australia and seen as an effective way to generate additional income or secure a stronger financial position. Property investment strategies generally take two forms: capital growth or rental yield.
Let’s look at these two more closely.
CAPITAL GROWTH
Capital growth is the increase in the property’s value.
Properties with strong capital growth are often found in highly sought-after areas, especially those with great access to amenities, commuting options and lifestyle benefits. Often this is called the PIE factor - population, infrastructure, employment/economic drivers.
The reason this type of growth is so valuable to investors is twofold. Firstly, it is an increase in profit when sold, but also it provides additional equity that can be accessed and leveraged to other investments.
Capital gains properties are usually negatively geared, due to higher purchase prices, due to PIE factors. Negatively gearing is a popular investment strategy as the Australian tax law currently allows investors to deduct any losses from their taxable income.
However
It is impossible to predict how the property market will perform in the future. It also pays to bear in mind that property values may not continuously rise. Sometimes values dip, at other times values remain static. This is important as the full benefit of the investment is usually not realised until sale time, sometime in the future.
Purchasing in high demand areas also means these properties are often more expensive to purchase and manage. A negative cash flow investment means that there is a weekly cost in holding such an investment, and investors need to calculate how to cover this.
Entry and exit costs also need to be calculated into the profit margin. Entry costs when buying, such as lending, stamp duty and legal costs, and exit costs when selling, ie. real estate agents commission, advertising fees, may eat into the capital growth profit.
RENTAL YIELD
Rental yield is income received by way of rent.
Properties with good rental yield are normally in outer Metro and regional areas where new developments are underway, such as mining and manufacturing, or even upgraded transport or new shopping hubs. This creates high demand in an area that has limited existing properties.
Due to their location, such properties are usually not as expensive to purchase, and the associated costs, such as taxes and mortgage payments, are consequently lower.
Targeting rental yield as an investment option generally means the property will be positively geared, where the rent from the property is higher than the expenses. Owning a rental property is one of the most popular ways of creating passive income, similar to dividend investing.
However
Rental yields are susceptible to fluctuations, and therefore income, such as seasonal variations or national crises. For example, Covid-19 saw rental demand drop in inner CBD areas, yet rise in regional areas.
Rental yield properties may not experience the same level of capital growth over time, so investors are more inclined to buy and hold for the long-term.
Annual expenses such as insurance, repairs, council rates, depreciation, mortgage payments also need to be calculated into the yield margin.
OTHER FACTORS
Weekly Costs
While budget and borrowing capacity is usually the first thought, it is critical to calculate the weekly holding costs on a property.
The cash flow forecast should include incomings ie. the rent, and outgoings, ie. all expenses. Tax write-offs from depreciation are an important consideration, as this will factor into selecting a new or an older property. For example, older properties are cheaper to buy but newer properties would have fewer maintenance costs.
Multiple Markets
Properties come in all sizes and locations, and therefore the property market should really be seen as multiple property markets. Different states and territories have different factors. Each capital city has an inner CBD ring, and then middle and outer suburban rings.
Then there are free-standing houses, apartments - high rise or medium density, townhouses, villas etc. Then there are also new and established properties. All of these market segments behave differently.
Non-Economic Factors
Real estate is one of few asset classes where buyers can be driven by non-economic factors such as family or cultural affinities, school zones or employment and lifestyle needs. Some see housing as a necessity and not as an investment and will make the final decision based on emotions.
IN CONCLUSION
Historically low-interest rates and government incentives are driving growth in the residential market for many areas around Australia. Deciding whether to base your investment strategy on capital growth or rental yield depends on your personal financial situation and future goals.
Please don’t hesitate to get in touch with us to discuss your investment trajectory.