Rental yield vs capital growth: Where do you find the best returns?
Category Newsletter: Lead Article
It's a conversation - or rather a debate - property investors love to have: When it comes to investment property what matters more, rental yield or capital growth?
As with all answers to questions around good property investments, there is no "right" answer, or a simple one-size-fits-all piece of advice.
We asked Michelle Cohen, principal at Leapfrog Johannesburg North East & Sandton, to help us unpack the question.
Investors get distracted by the rental amount they see coming in each month, but in the long run it's capital growth that sets a good investment apart from a great investment.
"Let's take a property of R1 million as an example. It is very possible to get R7500 rental income each month. That's a significant R90 000 a year, before costs like levies, rates and other expenses associated with the property," Cohen explains.
But all that glitters is not gold - just because the monthly rental income from the property is good, doesn't mean the capital growth is necessarily what you would like it to be.
"It's easy to get sidetracked by the glitter that is the high rental yield. But gold - your capital growth - is worth much more than glitter in the long run. Both may sparkle now but with a property investment long-term performance is usually what matters most," Cohen elaborates.
And this is simply because capital growth is the value of a property over time, whereas rental yield is just the cash flow of the property.
Consider the same property as above. It's likely that the property could enjoy capital growth of 6% per annum. 6% of R1 million is a not-insignificant R60 000 per year.
But that's less than the annual rental yield? Yes, but what matters here is the overall appreciation of the asset. This property added R60 000 to its value, while the R90 000 was just cash flow - it didn't add to the value of the property. But let's compare apples to apples. Imagine the monthly rental increased by 5%, given current market conditions That would mean R375 extra each month, or R4500 per year, which is a long way from the R60 000 capital growth, even after expenses.
Cohen continues: "What's more, capital allows an investor to leverage an asset to expand their property portfolio. Successful real estate investors know that is is very difficult to save for a deposit for the next property investment, using only rental income. Instead they leverage the capital in their high-growth properties to use as deposit for the next purchase, and so on."
"Another factor that is often overlooked is that the profit on rental income is taxable while capital growth is not," Cohen points out.
Depending on the type of investment it is, together with your financial and investment goals, there are times when rental yield is as important as capital growth but mostly it's the latter that sets the comfortable investor apart from the wealthy investor. "Another way of understanding this is to see rental yield as the cash flow that looks after the asset, but it doesn't grow the asset." Cohen explains.
At the end of the day, the decision rests on the investor's financial needs and investment goals. Our best advice is to consult a trusted property professional for advice and guidance related to a sound property investment in the right area.
Author: Leapfrog
