Information that will guide you to selecting the best purchase for your goals
As investors, we hear time and time again about the benefits of high rental yield, versus the benefits delivered from high growth assets – and it is important to address which of the two is best for the next property you add to your portfolio.
Quite simply the term yield refers to the income we receive on an investment as a percentage of the cost and it is normally determined on a per annum basis. For example, if we purchased a townhouse for $500,000 and the rental income from that property before any costs was $25,000 annually – the property would have a rental yield of 5%p/a. If we purchased a unit that cost $300,000 and the rental income from that property was $18,000 per annum – the property would have a rental yield of 6% p/a. We can see from the above example that even though there is less income coming in, the outlay originally was significantly less – so the return on investment is much better.
A rental yield of 7%p/a, is significantly better than a rental yield of 4%, because we are not making an additional investment return of 3% p/a, in actual fact the additional investment return is an additional 75% p/a, so it is very important to do some calculations – always remaining conservative when it comes to the rental yield of the property. There are still regional areas in Victoria where it is possible to attain a rental yield of 5%-7% per annum on a property, which in most cases will ensure with a 20% deposit, the property is cash flow positive.
The benefits of having a high-yield investment will traditionally be more geared towards investors on lower incomes with borrowing restrictions, those who are growing or beginning their portfolio and those who rely heavily on high rental income to supplement the ongoing costs of the property. A higher rental yield will allow you to pay the property off faster and require less cash input from you as an investor generally.
A heavy consideration when considering the purchase of a high return asset is that you won’t enjoy the tax benefits associated with negatively gearing a property if the property is profitable – but every smart investor knows you don’t spend additional and unnecessary money purely to minimise tax. Other considerations will be the costs of owning these properties – for example of a property has higher costs, the rental yield may be negligible – in situations where the property has high owners corporation fees, high insurance and expensive maintenance the high rental yield becomes irrelevant.
Growth refers to the value of the asset increasing over time – and is something that will only be realised when the asset is sold or equity is unlocked. In more recent years within the Melbourne property market, we have seen phenomenal growth which in nearly all cases has certainly resulted in much better performance than a higher rental yield – we can’t, however, rely on this being true moving into the future.
We calculate the growth of an asset quite simply by deducting the original purchase cost from the current value. For example, if we purchased a house at a cost of $500,000 and it is now worth $900,000, there has been growth of $400,000 or 80%. To break this down on a per annum basis, you divide the growth by the number of years the asset was held – for example, if the house was owned for 10 years, it would be 8% p/a growth.
The benefits of having a high growth asset are that you can unlock the value without necessarily selling the asset and use it to continue to build your wealth or portfolio. We have also found that high growth assets in the right locations have outperformed high yield assets in recent years – but that not something we should rely on. Additionally to this, a high growth asset will in most cases also go hand-in-hand with a lower rental yield (It is near impossible to find properties that have both high yield and growth – these get snapped up for high prices very quickly) and therefore may offer taxation benefits by way of negatively gearing the property.
The biggest consideration when considering the purchase of a high growth asset is that it is an unreliable investment return. Whilst traditionally we expect an increase of asset value of around 6-8% per annum in our bigger metropolitan cities – this isn’t always the case and must not be relied upon. For example, we have recently seen a downturn in the Melbourne property market of around 10% within the inner areas over the past 12 months – this could cost as much as $80,000 on an $800,000 property purchased at the height of the market. Another consideration is that in order to realise the profits of this, Capital Gains Tax will generally apply and can seriously pack a punch to the profit margin. The final consideration is that holding costs and a lower rental yield will deplete the profit further and of course must be taken into consideration when making a decision to gamble on purchasing a property with the view to gaining capital growth.
So which should you choose? Yield or Growth?… Well, it’s very difficult to answer this question – and it is completely dependent on your financial situation and goals as a property investor. Personally, I believe that a strong property portfolio will have a combination of higher yield properties to ensure that the bills are paid – but also a mixture of some properties with some good growth prospects to ensure you are capturing both sides of the investment return.
If you are planning on replacing your employment income with rental income, and won’t necessarily realise the results of the value growth, consider assets that have a lower cost base and a higher rental yield – as this will help keep your income higher with less investment – and may result in a more spread property portfolio with lower risk factors and higher income.
If you think you will probably sell the properties to attain the growth and use the profit to invest elsewhere or pay down debt – and you have additional income to support the higher costs and lower yield of the property – then it is worth considering the purchase of properties with higher growth prospects. Once sold, if the properties attain a large result with higher growth – then they have been worth the risk for your scenario.
Overall – you must consider your own individual position and goals for the portfolio and how you intend to treat the portfolio long-term. Traditionally, I have considered that properties with higher rental yields tend to have a more solid and predictable investment outlook – and so risk-averse clients who aren’t able to support additional property through their own income must consider these as an advantage – whilst clients with higher disposal income who are happy to play a game of risk for the benefits of properties with better growth prospects should consider adding these to their portfolio. In summary – both properties are suitable for different portfolios and different investor profiles – and it will come down purely to your individual circumstances.
Of course, I am not a financial advisor and any information offered here is general in nature only – so if you’re unsure about the best path forward when buying your next property, certainly gain the advice of a professional.
A little about the author….
Jacob Visser is an industry leader within Property Management and as the Head of Property Management with Hamilton Property Mangement offers unique insights into Property Investment and the rental market. Starting his property portfolio at 21 has allowed Jacob years of experience and he acts as a wealth of information for the fast-paced and exciting world of Property Invesment. Jacob can be contacted directly on 0447 316 406.