Capital Growth vs Rental Yield: Who Actually Wins?
Every property investor is looking for the secret to success, aren’t they?
Some spend years searching for a mythical investment strategy that will be their path to untold riches.
Alas, while they are on their unhelpful hunt, they miss golden opportunities that could have helped them achieve their financial goals and dreams much earlier.
One of the most common mistakes that novice investors make is being fixated on rental yield instead of on capital growth, which is where the secret really lies.
To prove my point, let’s take a look at some capital growth facts.
1. It’s the key to duplication
The thing is most people’s incomes mean they only have the capacity to invest in one property at a time.
These days you can’t invest in property without a deposit and it’s always been hard to save one of those.
The key to growing your portfolio is duplication, which necessitates more deposits.
It’s highly unlikely that many people can save multiple deposits over their lifetimes.
But what they can do is use the capital growth (or equity) in their properties instead.
If they’d invested in cash flow properties, while they might have solid rent coming in, it generally won’t do anything to help you with a deposit for your next property.
2. A question of debt
How do you feel about carrying debt?
Some people can’t sleep at night for fear of a market crash or interest rate rise.
But, as I’ve said before, a good debt like mortgages on investment properties can provide you with leverage to magnify your gains.
Yet in order for this to work, you need to have gained to start off with, which isn’t necessarily the case with cash flow properties.
I’ve seen more than my fair share of investors whose borrowing capacity has been limited by owning low capital growth assets, which prevent them from borrowing to buy better-performing properties.
And of course, in today’s low-interest-rate environment, good debt is really an asset because you can borrow funds at around 2-3% while a well-located property that you will buy with that debt will increase in value at twice or three times that rate.
And it’s likely that your cash flow shortfall will be minimal in this low-interest-rate environment.
3. Less than ideal liquidity
It should come as no surprise that cash flow properties have less than ideal liquidity.
What I mean by that is they can be more difficult to sell if your circumstances change.
Plus, you’ll likely walk away with very little additional proceeds from the sale because it hasn’t increased in price overly much.
Selling real estate also carries high divestment costs such as agent fees and advertising, which will further eat into any potential profits from a cash-flow property.
On the other hand, an investment-grade capital growth property will be more attractive to potential buyers and you’re likely to walk away with much more money in your back pocket after the sale.
4. Equity means choices
My final point is that if you buy a property that doesn’t grow in value you have to hope that the rent continues to cover the costs of ownership.
But the fact is that it’s unlikely that you’ll get rental growth in a location where capital growth is minimal.
But if you buy an investment property that goes up in value, you have a number of options that increase over time.
If you want to, you could use the equity to buy another property and maybe refinance in order to free up cash flow for other investments.
And it’s likely the rent you receive will also keep increasing.
Another strategy could be to renovate to add value or you might choose to sell it at the point of retirement in order to pay down debt.
So which is better?
Chasing a magic property investment formula can be a fruitless exercise and if you do what most property investors do, you’re likely to get the same result – your wealth creation journey will come to a halt while cash flow keeps you in the property game, it’s really capital growth that gets you out of the rate race.
That’s why I recommend you only buy investment-grade properties – the type of real estate will always be in demand by owner-occupiers and in locations that will continue to be desirable because of their proximity to infrastructure and amenities.
The fact of the matter is no one ever saved their way to financial freedom.
No, they invested wisely in assets that grew in value over time to provide them with a lifestyle everyone dreams of, but unfortunately, relatively few accomplish.
