Rental Yield And Capital Growth Serve Different Investment Goals
Investment in residential property can take multiple forms and serve different goals. Before jumping in, smart investors lay out a game plan that outlines these goals and how the investment will work to meet them.
The two main ways that investors earn returns on property investment are through the property yield or the capital growth model.
The Rental Yield Model
The term “yield”refers to how much cash a revenue-producing property generates annually as a percentage of its value. Property yield is calculated differently than other assets that create yield. Investors find yield to be a handy measure to compare asset classes and how they should perform.
The yield is the rental income’s percentage of total property value. Yield is not the only factor to consider when buying a property, but it is among the most important.
Low yields do not only affect the bottom line of a single real estate asset but can also affect your ability to borrow money to purchase other investment properties.
One can look at rental yield in two ways:
- Gross rental yield serves as the annual rent and is calculated as a percentage of the purchase price or appraised value of the property.
- Net rental yield subtracts the property expenses, but not debt servicing (especially mortgage payments), from the gross yield.
If the current value of a property is $360,000 and yearly rental income is $26,000, find gross yield by dividing the rental income by property value, then multiply the result by 100. This gives a gross yield of 7.2 percent.
Yield Impact On Borrowing Power
Higher rental yields can deliver in terms of borrowing power, either for improvements on the current property or purchase of another.An extra one percent yield on a $1 million property, for example, can result in an added $50 – $60,000 in borrowing capability.
The Capital Growth Model
Capital growth can occur in two ways.
In the first, more traditional manner, the purchaser buys a property when they anticipate that the value will rise over time.
- Examples of this include land or structures close to areas of new highway construction or suburban expansion.
- Those looking at this model must remember that property taxes will increase right along with assessments in most areas.
In the second type of growth model example, owners may choose to acquire a property with the goal of making improvements, then reselling quickly, also known as flipping a property.
They assume a substantial risk and believe the increased value added by improvements will provide profit in the deal.
Property Investment Advice for Both Types of Investments
Both models above offer strong opportunities, but also feature potential challenges.
Yield Model Pros and Cons
Investing for yield has the potential to provide a regular and steady income that, during the full life of the investment, can accumulate and lead to more revenue than the growth model.
When the rise in property values coincides with improvements in the surrounding community, yields can increase as the market gains the ability to shoulder higher rent or lease charges.
This model often better serves the needs of certain types of investors, such as those close to or in retirement age, who have less time to wait out for returns.
The yield model provides no guarantees, however. Many rental properties respond to economic changes both good and bad. If the surrounding area deteriorates, rent income can drop while vacancies rise.
Growth Model Pros and Cons
The growth model also includes an element of risk to go along with the opportunity. Just like an investment into shares, the investor buys in anticipation of value growth. Unpredictable market conditions, regulatory changes, and other factors can change a property’s potential to appreciate in value quickly.
In both cases, the investor should spend not only money but also time. They need to research the area, its government, and its economic trends and potential to see if the purchase lines up with their investment goals and the model they plan to utilise.