The two components of return: capital growth and rental yield

Posted by Joshua Mellick

There are two significant aspects of investing in property: capital growth and rental yield. Capital growth is the price of the property increasing over time, while rents offer a source of liquid income. The term “total return” is simply adding the two components together.

You must have a strategy in place to navigate your investment journey. Property can typically be separated into two types – they can either be high growth or high yield. It’s unusual to find a property which has both characteristics and most exist on a continuum between the two ends of the spectrum. Educating yourself before embarking on your journey will aid you in purchasing high-quality assets along the way.

Rental Yields

Understanding what the term rental yield means and how it’s calculated, will give you a better picture of how much you’ll make over time and how much it will cost you to hold a particular property. It can also come in handy when it’s time to re-evaluate the rent on a rental property.

Rental yield is calculated as the sum of all the rent you will collect over the course of a year, divided by the price of the property. Its usually expressed as a percentage. Some people will actively target high yielding property at the expense of capital growth.

Rent provides a reliable source of income. You will get a monthly or weekly income from the property as long as you have tenants. If you purchase a property that is ready to rent out, you can begin generating income from it immediately.
You’ll have more money in your pocket if the rental yield is high. You can use the income from rent to pay for the mortgage instead of relying on other sources of income. This results in less of an impact to your current lifestyle.
Invest in areas with low vacancy rates. If the demand for property is likely to consistently outstrip supply, you will be able to increase your rent over time. Over time the rent will more than cover your interest repayments and your property will become cashflow positive.

Capital Growth

The increase in the price of an asset over time is referred to as capital growth. It means that someone is willing to pay more for your property than you purchased it for.

For example, you might purchase a property for $500,000. That property’s price might rise to $600,000 in two years. This indicates you’ve made a $100,000 profit on your investment. If you sell the property now, you will make a 20% or $100,000 profit.

Negative Gearing. This is a common investment strategy and usually unavoidable for the majority of investors. It entails investing in real estate knowing that it will cost more in interest and other expenses than you will make in rent. This loss you incur reduces your tax base. You can utilise negative gearing to pay less tax and manage your cash flow.
Often better returns. Many people who want to grow their wealth buy properties in areas which have had a history of good capital growth. Another more speculative growth strategy is buy in areas that are about to undergo a significant change – an example would be a suburb that is gentrifying or is about to receive a significant infrastructure upgrade.

Property with higher capital growth is what Blue Wealth typically focusses on. Having said that there may be times when a high yield, lower growth property may be a useful fit for a portfolio.

Posted by Joshua Mellick, on 25th Jan 2022