Capital growth and yield are two phrases that are synonymous with property investment and can have a large impact on the long term results of your property investment. Some investors often make the mistake of chasing yield over capital growth but before we look at the relationship between the two, it is important to understand the definition of each:
Yield: the annual revenue or rent from a property reflected as a percentage of the value of the property.
Capital growth: the amount the property goes up in value each year reflected as a percentage of the value of the property.
Many investors believe that by chasing high yielding properties they will make a faster profit than waiting for capital growth. The problem with this is that to achieve high property investment yield you usually have to compromise on capital growth. For example, you may receive a higher property investment yield in a country town but the long term capital growth may be in jeopardy if the town is reliant on external factors such as tourism or mining.
Therefore it would seem the most logical solution is to find high a yielding property in a strong capital growth area but in actual fact sometimes lower yielding properties have a better capital growth.
This is because there is generally an inverse relationship between yield and capital growth so the higher the yield, the lower the capital growth and the higher the capital growth, the lower the yield. This means property investment becomes all about balancing the scales.
To maximise capital growth in a high capital growth area you should invest as much as possible in the land and less in the buildings if you have the ability to service the debt but herein lies the problem because the yield is usually required to service the debt.
Not many of us can afford to service high levels of debt without a reasonable yield so that forces us to look at ways of making an investment affordable by finding the right balance between capital gain and yield.
Property investment yield is critical to the survival of an investment but it’s not the key to building wealth. Don’t chase yield for yield’s sake, but rather chase capital growth with enough yield on property investment to make it serviceable because in the long term it is the capital growth, not the yield that will generate you the wealth and the financial independence you are seeking.
Author: Don Crellin, Managing Director, Resolve Finance.
Source, Investor Assist, 2013, Full Article Here