Property capital growth vs rental yield

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24 May 2016

What is more important property capital growth or rental yield?

Author: Michael Cook

What is capital growth

Capital growth and rental yields are two ways you can make money as a property investor, so they are important to understand before you buy a property, and maximise opportunities whenever possible.

Michael Cook, Managing Director of Lettings at Romans, has years of experience in advising investors on the best type of properties to buy in order to achieve the best capital growth and/or rental yield, depending on their outlook, requirements and personal circumstances. Here, he explains the difference between capital growth and rental yield, and describes what to look out whether you want to focus on capital appreciation, rental yields, or both.

What is property capital growth?

The dictionary definition of capital growth is: Profit made on an investment or purchase of an asset, measured by the increase in its market value over the invested amount or cost price. Also called capital appreciation.

“Many property investors have a long-term ‘buy and hold’ strategy in mind, whether that’s five years, 10 years, or 20 years; capital growth is the amount of money you make when you sell your investment property” comments Michael.

“I highly recommend seeking advice from a property expert before you invest. They will have knowledge of the local marketplace and examples of the types of property that are more likely to appreciate in value.

“Depending on how long you plan on keeping your investment property can also affect the best type of property to buy at that time, and of course location is very important as this can have a massive effect on the value of a property.”

Local property experts know first-hand about off-market property, new developments, town regeneration and up and coming areas, which can all result in property values increasing over a number of years. Crossrail is a great example of this, and shrewd investors have been buying properties in the towns where Crossrail stations will be, such as MaidenheadReadingBurnham and West Drayton as their value is predicted to increase dramatically.

“It’s also essential to purchase a property that will sell when the time comes to liquidate, because after all, a property is only worth as much as someone is willing to pay for it” adds Michael.

What is rental property yield?

Rental yields signify the rate of return from an investment. Estate and letting agents, such as Romans, will often include the expected gross rental yield on investment properties being marketed.

Estimated rental yield

  • How do you work out the net rental yield?

To calculate the approximate net rental yield, and workout how viable an investment decision is, simply subtract annual expenses from the annual rental income, and divide this result by the total cost of the property. Multiple the result by 100 for the net rental yield percentage.

For example

Net rental yield

N.B. Annual expenses include repair costs, property taxes, landlord insurance, and agent fees

  • How do you work out the gross rental yield?

The gross rental yield is simply the annual rental income divided by the total cost of the property, multiplied by 100.

For example

Gross rental yield calculation

What is more important; property capital growth or rental yield?

“Every investor I talk to is looking for something different from their investment(s), and more often than not both the capital growth and the rental yield are important” adds Michael.

“You should definitely consider both before you purchase an investment property. Even if you’ve become an accidental landlord understanding what capital appreciation and rental yields you can achieve will help you plan how long you intend to hold onto the property before selling it.”

Property capital growth strategy

Property investors focussing on capital growth tend do so for a number of reasons, from funding retirement and supporting children to hedging poor returns on savings.

Typically these investors will look out for properties in nicer, perhaps more central, locations with good kerb appeal, and buy homes that they could imagine living in themselves.

These types of investment normally follow a long-term investment plan so they will be eager to buy in areas expecting regeneration, and looking for opportunities such as the ‘Waitrose effect,’ whereby studies have shown that capital values can increase by 25% five years after the arrival of a Waitrose supermarket.

These investors strongly believe that the economy is improving, and are confident house prices will continue to rise. They tend to put down a larger deposit so their mortgage repayments are covered by the rental income. They tend to like newer properties in commuter towns with a strong demand from young professionals.

 

Rental property yield strategy

Other investors prefer to focus on the rental yield they will receive each month, and look at investment as a top up on their existing income, or they’re using property investment to actually create an income if they’re retired.

They are often keen to pay off their mortgage as quickly as possible so will look at smaller properties at the bottom end of the market, and will often buy several buy-to-lets rather than one. They too are hedging poor returns on savings, but also hedging against any increase in interest rates.

Many of these investors prefer older properties in areas that may be due to undergo significant change, but also larger properties, which perhaps are not so central, with a strong demand from tenants.

These investors tend to be led by the numbers and will invest based on initial calculations.

Capital growth and rental yield strategy

For many investors a combination of strong capital appreciation and strong rental yields is important. Once you’ve found the right property you may have a lot of competition from other investors and first-time buyers which can push the price up.

So although you may not find a ‘bargain’, you can rest-assured that you’ve explored all of the options and the property is expected to not only provide you with an extra monthly income, but also good capital growth in five, ten or 20 years’ time.

Michael concludes: “As with all investments there are no guarantees, and the rental yield and capital growth are estimates based on the current marketplace and housing policies.

“By talking to a property investment expert you will feel more confident that you’re making the right decision, and with prices expected to continue rising it might be something worth exploring sooner rather than later.”

To find out more about property capital or rental yield investment arrange an appointment with the lettings investment team at your local Romans branch by calling 01344 985 699.

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