Capital growth vs rental yield: which is best?
Starting out in real estate investing can feel like a bold move, especially if you are concerned about making a bad investment. This is one reason why a trusted educational resource is important for gaining enough knowledge to stay safe and profitable. Understanding capital growth vs rental yield is a good example. While you may have heard of the two terms, we shall look at them both in detail with the aim of helping you to make more confident decisions.
Which is the right one for you
Before we explore the virtues of capital growth vs rental yield, it will be worth understanding that it is similar to asking, which is better – a spanner or a hammer. The answer is of course obvious. It depends on what it is you want to do – a different tool for a different job. Although, granted, there are people who claim a hammer can be used to fix anything!
As a property investor, capital growth is a tool that will meet certain needs. Likewise, rental yield will also meet certain needs, however, they will be different needs. So, the first question for you to consider is, which of your needs do you want property investing to meet? This answer will be different for each individual.
Some investors may only need cashflow, i.e. rental income being paid into their account each month. Some investors may need a nest egg, an investment that will pay dividends in the future. Whereas some investors may need a bit of both. Deciding on which type of income you need will shape your options as we explore capital growth vs rental yield.
What is capital growth.
In simple terms, capital growth, sometimes called capital appreciation, is an increase in the value of a property during your period of ownership. If you purchased a property ten years ago for £100,000 and today it is worth £150,000, you have benefitted from a capital growth of £50,000. So, what can cause capital growth?
Capital growth could simply be caused by a general increase in house prices, although for a significant increase this could take double-digit years. It could be due to new local developments and infrastructure such as local area regeneration schemes, large-scale new employment opportunities or new transport links to commuter hubs.
Capital growth can also be manipulated by the investor however. Sometimes called forced appreciation, property investors will often seek to buy properties where the value can be increased through development work, title splitting or even just a good a bit of modernisation. Things to look for are properties that can be reconfigured to have an extra bedroom or ones that are in a state of disrepair; what we call distressed properties.
What is rental yield?
Rental yield gives the property investor a very broad indication of how profitable a buy to let property will be. It is a comparison of a property’s rental income against the price you paid for the property. Rental yield is calculated by taking the annual rental income from a property, dividing it by how much you purchased it for and then multiplying by 100. For example:
Annual rental income of £8,500
Divided by a purchase price of £100,000
Multiplied by 100
Rental yield has several limitations that restrict its reliability, such as the loan to value amount of the property, the costs of refurbishment or the amount of actual rental profit once all costs have been deducted. For professional property investors a return on investment (ROI) calculation is much more reliable and you can learn more about it here, along with what is a good rental yield: Do You Use Rental Yield or ROI?
Capital growth vs rental yield compared
As we can see, capital growth is chiefly concerned with a property’s value in the future. This increase in value can only be released from the property by either selling it or remortgaging it. The amount will therefore be a lump sum of cash to use as you please – perhaps to purchase another buy to let investment.
Rental yield, on the other hand, is an indication of monthly rental income which will be money paid into your bank account for the period of time that the property is tenanted. Whereas capital growth can provide one-off large sums of money, rental income will be a trickle of money but over a long period of time.
The right tool for the right job
At this point we circle back to the question: what do you want to achieve by investing in property? Do you want to be buying property with the main goal of generating large sums of money in the future? Or do you need to earn rental income right now?
Of course there is often a crossover. It is possible to own a residential rental property or a commercial rental property that will both earn rental income and increase in value as time goes by. However, in areas where house prices are very high, it may not be possible to earn much profit from rental income due to the high mortgage payments, but a property could be expected to double in value in ten years’ time. On the flip side, areas of low cost housing could produce high returns from rental income but the value is unlikely to increase by very much.
These are considerations that are down to you, but are considerations that will determine what is the best property investment for you. If you want further help with understanding the best options for your needs, why not join a one hour live Discovery Webinar. They are free and will cover the basics of how property investing works and how it can benefit you. In the meantime we have lots of other free help and tips in our blog and podcasts, such as: How Do You Select and Investment Area.