As a property investor, you must wisely align your strategy with your goals. Choosing poorly will cost you in the long run.
Rental-yield strategy and capital-growth strategy are two ways to earn money as a property investor. But you must understand how they work and their pros and cons before you buy.
What is Rental Yield?
Rental yield is a measure of the return on your investment from rental income. It is a comparison of the cashflow of the property to the cost of owning it, expressed as a percentage. Understanding what it is and how to calculate it is necessary for shaping your investment goals.
If you have a hard time covering the costs of owning a property or don’t have a large deposit saved up, a rental-yield strategy might be right for you.
Pros And Cons Of A Rental-Yield Strategy
|You can generate positive cashflow||You have to pay taxes on the rental income generated|
|It is a means of earning money from property investment when you don’t have much equity||The kinds of properties that support this strategy are those found in regional areas or mining towns where growth tends to be slow compared with metro-area suburbs|
|Surplus rental income can pay down your mortgage, allowing you to increase the equity in your investment property
||Banks will not lend for purchases of properties to be used for this strategy in areas where the risk of default is found to be higher|
|You can borrow with a lower deposit to buy a suitable property for less in greater-metro areas||Tenancy problems can leave the property vacant for too long|
What is Capital Growth?
Capital growth is an increase in the value of an investment over time. Building capital can be a long-term strategy that requires patience, although Australia’s real-estate market has been hot enough at times to generate substantial capital growth quickly. You make money by buying and holding onto the property until its value increases, then selling.
This strategy protects your wealth against inflation. Suppose you place cash in a savings account. Rarely would your money earn interest at a rate well above that of inflation. In Australia, residential property frequently gains in value at a rate well above inflation
A well-chosen property will have the potential to earn rental income and achieve capital growth. If you can afford management fees and mortgage repayments, then a capital-growth strategy might be the best choice for you.
Pros And Cons Of A Capital Growth Strategy
|The properties are not as vulnerable to economic shocks.||The prices for properties expected to show capital growth are usually higher.|
|Consistent capital growth over a longer term builds equity.||As the purchase price is usually higher, you end up paying more on stamp duty and land tax.|
|You can often generate equity in the short term as well.||There’s no guarantee of capital growth in the short term, so you might have to hold the property for a long time to make a profit.|
|You enjoy tax benefits, like deductions for negative gearing and delayed capital gains tax.||If your property portfolio is overexposed, then some lenders might not approve your loan.|
Which Is Better: Rental Yield or Capital Growth?
The answer depends on your financial situation and your investment goals. Both strategies offer good overall returns, with their own respective financial rewards and risks.
A balance between the two strategies would be ideal. However, your capital growth will earn you exponentially more than your rental income in the long run. On top of that, it can be challenging to save for a deposit to continue building up your investment portfolio if you are relying on only rental income.
Here’s a more detailed comparison of capital growth and rental yield:
|Capital growth||Rental yield|
|While you may not gain significant cashflow, you have the potential to earn a big profit when you sell your property.||You receive a steady cashflow (provided your property is positively geared).|
|You look for properties in areas that will increase in value.||You look for properties in areas that have great appeal to tenants.|
|Properties are usually located in high-demand suburbs.||Properties are usually outside metro areas, where property is more affordable and rental return is high.|
|Associated with high entry costs, as you need to budget for stamp duty, which increases with the price of the property.||Rent payments will cover the ongoing costs of owning property but you pay tax on rental income.|
Need Help With Your Investment Loan?
If you’re having trouble deciding whether a capital-growth or rental-yield strategy is best for you, Home Loan Experts can help. Call us at 1300 889 743 or enquire online to find out which lenders can help with your investment loan.