Financial return – growth, yield or balanced?
When determining your goal for each property you intend to purchase, you need to ascertain the financial return that you are striving for. In the case of an investment property this could be Capital Growth, Yield or a Mix.
As a general rule, properties that provide the greatest capital growth over time provide a lower rental return yield as a percentage of the value of the property at the time of purchase.
For example, if you look at suburban established properties in major capital cities like Sydney and Melbourne where capital growth over the long term has historically been very strong, the rental income as a percentage of the value of the property is often lower when compared to most rural locations.
Conversely, the properties that tend to provide the greatest rental return as a percentage of the value of the property tend to provide weaker capital growth.
For example, if you look at regional areas, the yield percentage return will often be higher than that of the capital city in that state. You might see that the rental yield for houses in Sydney or Melbourne is closer to three per cent whereas in regional areas it is closer to five per cent.
This paragraph is worth re-reading as it is an important tenet of property investing that confuses many and is often the cause of poor purchase decisions.
Your aim should be to find a property that will provide a rental return that meets your cash flow needs, whilst providing a consistent demand from tenants which points towards solid long-term capital growth prospects. Whether you opt for higher capital growth or higher rental return will depend on your property strategy in relation to your goals, affordability levels and stage of life. The bad news, when it comes to a capital growth focused strategy, is that it takes more ongoing cash flow contribution to purchase a capital growth focused property initially. The good news is that strong capital growth historically has been the greatest wealth builder through property in Australia.
Importantly, rents tend to grow at a faster rate over time if the capital growth is strong, despite the return relative to the value of the property being lower.
This means in the long run you win from growth in value and rental income. For example, your capital growth might be seven percent per annum, and the rental yield three percent, but the rental yield needs to grow at seven percent annually to remain at a three percent yield. This means that the yield of a high capital growth property today might be lower than other properties as an absolute dollar figure that it will surpass in rental yield into the future.
This concept can be difficult to comprehend so please feel free to raise this topic in our Property Strategy meeting.
Opportunity Cost with difference of 3% Capital Growth
Note: Starting price of the property was $600,000
|Length of ownership||Scenario ACapital value3% growth pa||Scenario BCapital value6% growth*/ pa||Opportunity cost|
The Property Planners Fast Fact – Capital Growth and the Consumer Price Index (CPI)
The Consumer Price Index (CPI) measures changes in the price level of a sample of representative consumer goods and services. The annual percentage change in a CPI can then be used as a measure of inflation.
This essentially represents a change in the ‘real’ value of money. As the CPI and inflation increases, the real value (purchasing power) of the same amount of money falls. For example, if an item costs $1, and then the CPI over the next 12 months is 3%, then that same item now requires $1.03 to purchase. The actual value of the item has not increased, but the amount of money required to purchase it has – because the money used to purchase it has reduced in value.
CPI is generally excluded from all property growth statistics, including Capital Growth. This means that if the CPI for the last 12 months was 3%, and the Capital Growth for a particular property is also listed as 3% for the same 12 months, essentially the property has not increased in value at all in real terms.
Similarly, if a property’s capital growth rate is lower than the CPI for a particular time period, then that property has actually decreased in value.
As a further example, if the CPI for a period has been 3%, and the stated capital growth for a property has been 7%, then the true capital growth is 4%.
David is the Founder and Managing Director of Property Planning Australia, author of ‘How to Succeed with Property to Create your Ideal Lifestyle’, co-author of ‘Property for Life – Using Property to Plan Your Financial Future’, co-host of the ‘Property Planner, Buyer and Professor Podcast’ and a widely-published media commentator. With more than 20 years of experience, David is passionate about educating others to make informed, and ultimately, more lucrative property investment decisions. David established Property Planning Australia in 2004 – with the vision to educate and empower Australians to make successful property, mortgage strategy and money management decisions. Property Planning Australia’s operations have earned acclaim and national industry awards for its unique fusion of property planning, education, money management, mortgage strategy and risk management. All supported by multi award-winning customer service.