All too often we hear people comparing different property investment strategies. Some swear capital growth is the only way to go, while others believe wholeheartedly that yield – or cash flow – is king. The truth is, both are proven wealth-creation approaches: which one you implement will depend on your own financial situation.
To establish which is appropriate for you, let’s take a look at the mechanics of each. For a property to achieve capital growth, it requires strong underlying demand, limited supply and a population of buyers who can afford to purchase it. For example, let’s say there are a thousand buyers all interested in one location, each with household incomes of $80,000. We’ll also assume they have a 10 per cent deposit. Their income will allow them to borrow around $500,000 and if you add their 10 per cent deposits ($50,000), they can afford to buy a property up to $550,000. It is, in theory, impossible for values to climb higher than $550,000 because demand is limited by the local incomes. However, this certainly isn’t the case in large cities, where higher income prospects are available, meaning buyers can borrow more and influence the capital values of property. In areas where there is strong demand and where income growth is above average, the value of property will continue to outperform over the longer term. We call these locations capital growth areas.
In regional areas, income growth prospects are usually lower, so capital growth is constrained. However, some can attract above-average yields, driven by two factors. First, if the population prefers to rent (common in mining towns with few lifestyle benefits for the long term) or the population simply can’t afford to buy in that location. As a result, demand to rent property is stronger than demand to buy, which supports strong yields. Second, if there is a shortage of accommodation available to rent, this also pushes up the rental return for investors. So which strategy is right for you? Investors chasing growth properties require more surplus household cash flow to meet the shortfall between the rental income and the cost of holding the property. A yield strategy usually means the cost of holding a property is much lower, so less surplus cash flow is required. It can be a good option for households that don’t have a strong cash flow surplus or where surplus cash flows are likely to be impacted in the future. By opting for a yield strategy, these people can get their investment property journey underway.
The good news is, if the household surplus income eventually picks up, then the next purchase could be a capital growth property. Remember: your personal financial circumstances should determine your property investment strategy, not the other way around. The important message here is that both capital growth and yield are proven wealth-building strategies, so there are opportunities for all types of investors to achieve their financial goals.
Written by: Ben Kingsley