Capital Growth v Rental Yield – Which strategy is better for you?

Should you invest for capital growth or rental yield? It is the age-old property question that has never actually been answered. However, as cliché as it may sound, there is no right or wrong investment strategy. Instead, it is completely dependent on the psychological makeup of the individual; At the end of the day, one persons success is another ones failure.

With this in mind, this article will aim to neutrally detail the pros and cons of both strategies in order to help you figure out which strategy is more suitable.

Analysing the capital growth strategy

In terms of property, capital growth refers to the appreciation of an asset over an extended period of time. Investors looking for capital growth will often look to buy in high-growth areas where they believe median prices will increase in the long term. They will then aim to sell this property many years down the line.

Pros of investing for capital growth

• Interest rates are at record lows

As of May 2021, the RBA has kept interest rates at record lows in an attempt to facilitate the flow of funds in the Australian economy. Additionally, they have stated that they plan to keep the cash rate ‘low’ until at least 2024. This is obviously as a result of the unbelievably unique circumstances surrounding the COVID-19 crisis.

However, regardless of the situation, an interest rate of 0.1% presents prospective buyers with a fantastic opportunity to enter the real estate market without paying a sizeable amount of interest. This can minimise the actual price paid for the property, and therefore allow an investor to realise higher capital gains when selling in the future.

• Long term security

Over the last 100 years, Australian property prices have increased at an average rate of roughly 3% per annum. Essentially, despite the multitude of booms and busts that have occurred over the last century, research tells us that real estate is a very safe long-term investment.

Cons

• Investors often misread the market

Investors who are buying for capital growth need to rely on speculation. This is because at the end of the day, no one, not even the experts, can accurately predict the direction in which the market is headed.

With this in mind, there is no fool proof way to identify a potential high growth area. While gentrification can be an indicator of rising property prices, it is not always a tell-tale sign.

• Unforeseeable economic factors

Changes in economic conditions are often unforeseen, and have profound effects on property prices. The Great Recession of 2008 is a perfect example of this. In the years leading up to this major economic downturn, it was widely believed that the property market was the strongest it had ever been; The real estate industry was in the midst of a 10 year bull market, and didn’t look to be in any immediate danger. However, a range of unprecedented factors resulted in a complete meltdown of global financial systems, causing property prices to plummet. Research suggests that investors who purchased during 2006-2007 would have needed to wait at least 6 years in order to simply break even.

Analysing the Rental Yield strategy

The rental yield strategy refers to investors who will purchase a property with the intention of renting it out to prospective tenants. The principle behind this strategy is to receive steady income payments.

Pros of investing for rental yield

• Consistent income

By finding a tenant, homeowners can guarantee income for a certain period of time. With this in mind, investors do not need to wait around for decades in order to realise a return on an investment.

• Investors can use tenants to pay off a mortgage

Usually, a property is ready to rent out within a few months of purchasing it. With this in mind, real estate investors can essentially use tenants to pay back their mortgage. Even better, rental yields often exceed home loan repayments. As a result of this, investors can use extra money in order to take care of any issues with the property.

Cons of investing for rental yield

• Cash flow is not guaranteed

Many investors will enter the property market in the belief that they will be able to easily rent out their place, and therefore receive a stable, consistent income. Unfortunately, for some, the truth can be more daunting. First and foremost, it is important to account for vacancy rates, otherwise known as the percentage of rental homes that are vacant. While a rate of 3% is considered to be the equilibrium point, it is not uncommon for certain areas to have vacancy rates of up to 10%. Either way, there is always a possibility that homeowners will not be able to find an appropriate renter.

• Property damage

Property owners who choose to rent out their place face the very real possibility of a tenant damaging the property. In order to avoid this issue, it is suggested that prospective investors are knowledgeable about strategies that they can use to secure a high quality tenant.

Conclusion

Investing in real estate can prove to be a fantastic long term financial decision if it is done correctly. Ultimately, while both strategies have their pros and cons, they both have the potential to help investors achieve their financial goals.

With this being said, purchasing a property is not something that should be taken lightly; there are numerous risks involved, and it is important that prospective investors completely understand the process behind property ownership.

This article is purely detailing the pros and cons of two property investment strategies, and should therefore not be taken as financial advice.