Yield vs Growth. What’s The Difference?
One of the biggest mistakes we see when it comes to property investment, is a failure to understand the difference between investing for yield (rental income) vs investing for growth (capital increase in the property).
Traditionally, high yields and high capital growth are mostly mutually exclusive (generally, you can’t have both at the same time but there is the rare exception). For example apartments, particularly in or near the CBD, will typically have low growth (mostly due to oversupply) but offer a reasonably good rental yield (income as a percentage of the value of the property – a good rental yield will be between 5-6% per annum). The same apartment may only have a capital growth rate of 1-2% per annum.
Conversely, a house may have a lower rental yield (typically between 3.5 -4.5% per annum) but a higher capital growth (8% or above will see the property doubling in value every 10 years or so).
Now, both of these property options have their place in an investment strategy – but there’s a caveat. If you pay cash for an apartment (ie. no debt or borrowings), getting 5-6% return on your investment through rental income is not a bad proposition. Even if the property is only growing marginally, you will still be ahead (positive cashflow). If on the other hand you are holding that apartment with an interest-only loan, say at 2.8%, the rental income will cover the costs of holding the property, but with not much capital growth, you’d have to ask yourself ‘what’s the point’?
If you can pay cash for an investment property that’s a house (with land), regardless of growth, you’d still be ahead on a modest rental return of say 4% p.a. If however, like many investors, you’ve taken out a loan for that property, at 100% finance and interest only, you’d want to ensure that the property is giving you some reasonable growth. This way, even though you may not be paying down the investment loan, over time you will have increased the amount of equity you have in that property, thus selling it at some future date (ideally at least 10 years) for a decent profit.
So, in short, invest for yield if their is little to no debt but opt for capital growth where there is 100% finance or substantial borrowings.