Yield Versus Capital Growth – which is the better property investment choice?
When it comes to property investing we all have different goals – some of us are looking for regular steady income, for others it’s all about capital growth…
…and some of us want a property that delivers sky high yields, immense capital growth and can be viewed from our kitchen window...
Unicorn dreams aside, what should you be looking for when investing in property – yield or capital growth?
Let’s start by clarifying what each of these are first and then look at how these relate to your circumstances.
Let’s say you want to purchase a property worth £200,000 and it generates £750 a month in rental income (£9,000 a year); to determine the yield, you need to calculate the annual rental return as a percentage of the property’s value – i.e. £9,000/200,000 which would result in a yield of 4.5%.
Here however we’ve only calculated gross yield. You also need to take into consideration other costs you’re likely to come up against such as your annual mortgage repayments (unless you’re buying outright), ground rent, service charges, management fees (if you decide to use one), insurance and maintenance cost. You also need to take ‘void periods’ into consideration – periods where your property is empty which often occurs between tenants.
While it’s fairly obvious that property values rise at different rates throughout the UK, less obvious (and less discussed!) is that yields on residential properties vary too. Overall rental yields have fallen as house prices have increased faster than rental prices have risen – this is especially true of London where yields are now 3-3.5% (on average). According to the Office for National Statistics (ONS), UK-property prices have jumped 32% since 2011 but rents have only risen by 14%.
Yield is also important if you’re looking to secure a Buy-to-Let mortgage and don’t want to put more than a 25% deposit down. Lenders want to see that the rental income is 125% of the rental repayments and, they calculate interest rates at 5-5.5% to ‘stress test’ their calculations. The result of this is that you need a rental yield of over 5% to secure a 75% mortgage.
This is the value that the property increases by. If you purchase a property for £200,000 and sell 3 years later for £230,000 your capital growth is £30,000.
It’s worth mentioning that if you had a mortgage on the aforementioned property and you made capital payments (i.e. you paid debt down, not just interest) your equity would have increased but your “capital growth” would remain the same (i.e. £30,000 in the example given).
The highest capital growth areas are typically areas where change is about to happen that will attract more people to live there; new rail connections, improved rail connections and new employers moving to the area are typical examples. If the area is a regeneration area, you’ll have to wait until the regeneration has happened before tenants are willing to pay premium rental prices. If you’re considering a regeneration area with a high volume of new residential properties being built, you’ll have a lot of competition for tenants. A good example of this is Europe’s Largest regeneration site in Nine Elms, situated between Battersea and Vauxhall where 20,000 new homes are being built - but only 4,000 of them qualify as ‘affordable housing’.
So which is better – high yield or capital gains?
Like most things in life, it’s not as black or white as one being ‘better’ than the other but more about what your goals are and what stage of life you’re in.
If you’re in your 30’s or 40’s with your own home and a good salary you don’t necessarily need the extra income that rent will offer you – you’ll only end up having to pay high levels of tax on it.
At this stage of your life, you’re likely looking for asset growth, a pension provision or something for your children’s future to help with their university fees or assist them in getting on the ladder once they’ve flown the nest.
If you’re retired you might be quite ‘asset rich’ but have a lower income and receive negligible return on any cash you have in the bank; accordingly an asset that consistently generates income for you without landing you in the upper tax bracket is more aligned with your current needs.
Spend some time thinking through your own personal circumstances and your current and future goals before deciding what kind of property investment you’re looking for - and, if you’re unsure and need advice, get in touch and I can help you evaluate your options and find properties that will suit your needs.
We are a property investment firm. Our publications do not offer property investment advice and nothing in them should be construed as investment advice. The information contained in our publications is not, and should not be read as, an offer or recommendation to buy or sell or a solicitation of an offer or recommendation to buy or sell.