Capital growth versus yield

On the topic of capital growth verse yield in property, I generally find new investors typically fall into one of the three following categories:

1. Totally oblivious — investors in this category are largely unfamiliar with either property capital growth or property yield and have little to no understanding how each can impact on a property investment.

2. Partially aware — these investors have generally heard of capital growth and property yield, would struggle to provide an exact definition of each and know they can impact on a property investment but have a limited understanding of exactly how.

3. Generally aware — these investors are aware of both capital growth and property investment yield and can provide a basic definition of each, plus they know each can greatly impact a property investment and want to gain a clearer understanding of how.

If you fall into any of the above categories, especially the first one, there is no need to be embarrassed. Even some of the most experienced people in the property industry would struggle to clearly define how both property capital growth and property investment yield can affect the outcome of your investment journey.

Your investment property yield is the overall return of your investment, shown as a percentage of the amount you invested. For example, if you purchase a house for $400,000 and it rents for approximately $460 per week, it has a rental yield of around 6 per cent per year. This is because your total annual rent adds up to approximately $24,000 which is around 6 per cent of your initial investment of $400,000. A high-yield property investment may be ideal for investors who require a higher cash flow to service their loan repayments.

The capital growth (or gain) is the amount your property has increased in value, relative to what you paid for it. If the property you purchased for $400,000 is now worth $550,000 you have made a capital gain of $150,000 before costs.

Property investors have long debated the merits of capital growth versus rental yield because it is rare to find a property that delivers both as generally they have an inverse relationship meaning yield may be achieved at the expense of capital growth and vice versa. The balance between yield and capital growth may change as your investment goes through different property cycles.

Apartments tend to occupy the high property investment yield category of investment since the ratio of rent to value is generally higher than that achieved for houses. However, houses usually provide better long-term capital growth as they include the element of ‘land’ which apartments lack. Smart renovations on the right types of properties can also help to increase capital growth as well as rental yield.

High yields may be tempting in the short term, however it is generally accepted that capital growth should be the primary objective of property investment as this is where the major gains are made. However, seeking capital growth from your property may result in a shortfall where your rental income does not cover your mortgage repayments and you need to work out if you are able to cover this shortfall in the longer term if required. This is known as negative gearing.

On the flipside, a high-yield property investment may enable you to positively gear your property which occurs when the rental income received for the property is more than the mortgage repayments and costs of owning the property. In this scenario, you may be subject to income tax on the extra income derived from the property so it is important to seek professional advice to know which option is better suited to you.

Everyone’s financial position and investment objectives are different and that is why I believe your decision to focus on investment property yield or capital growth is a completely personal one which should be decided following advice from your investment specialist or financial adviser.

Whether you own one property or an investment portfolio, I believe a balance between capital growth and property investment yield is the best outcome. If you are able to forgo a little yield in the short term to get better capital growth in the long run, this strategy may prove advantageous. And if you are in a position where you have more than one investment property, focus on properties that represent overall good value and which are diversified by location and building type.

In simple terms, it is important to have a clear understanding of capital growth and property yield on property investment before you decide how and where you want to invest. Whether you choose to pursue property capital growth or high yield property investment will depend entirely on your personal and financial circumstances, but you should have a clear understanding of your chosen strategy and its implications.