Why do so many property investors invest for growth?
While I always caution against property investment to make a quick killing, it’s certainly true that a great many investors buy residential investment property for capital growth. There are some major benefits of investing for growth. In this blog post, I’ll explain a few of these, and show you an example of the difference it can make to your wealth.
1. Property investment is the ultimate long-term wealth creator
Perhaps the most obvious benefit of investing in property in the UK is its incredible long-term growth potential. Over the last 100 years, property prices have increased by an average of more than 8% per year. It doesn’t look like it’s going to change anytime soon.
Demand for new homes has outstripped supply in the UK for several years and looks set to continue to do so. It’s estimated that the UK is building as many as 100,000 too few homes every year. This discrepancy between supply and demand could underpin property price growth for decades.
2. Capital growth helps an investor grow a portfolio faster
It’s not just long-term capital growth that creates wealth. Higher and more consistent capital growth generates positive equity more quickly.
This equity can be released by remortgaging. The released equity is used to fund the deposit on the next investment property purchase. It leads to faster portfolio growth and faster wealth creation.
Of course, this investment strategy relies on property prices rising, and not getting ahead of yourself. You’ll need to invest carefully, and take care to use the best mortgage products for your investment. Capital growth property investments tend to be negative cash flow investments. With mortgage payments and costs higher than rental income, you’ll need to subsidise them from other income. Cash flow considerations and careful cash management are a key to successfully investing in property for capital growth.
3. Lower income tax bills
The way that rental income is taxed is changing. If you’re a higher rate taxpayer, reduced tax relief on mortgage interest payments could lead to higher tax bills.
Capital growth properties tend to generate lower rental income, particularly when you first invest. While you’ll probably need to subsidise your investment, you could also find yourself paying less income tax than you would be when investing in a higher rental yield property.
4. Growing income produces positive cash flow when you need it
Let’s say that your capital growth investment property generates a 4% rental yield. As its value rises, if you can maintain the same yield then, your rental income will increase.
Let’s assume you buy a property for £300,000, and the rental yield is 4%. In year one you’ll receive £12,000 rental income. If you have invested with a £200,000 mortgage at 5%, your mortgage payments will be £10,000. After investment property management costs, maintenance, etc. you may have a negative cash flow of, say, £100 per month.
Now. Let’s consider that the property rises in value by 10% per year, for five years. After five years, your investment property would now be valued at approximately £483,000. If you can maintain a rental yield of 4%, your rental income would rise to around £19,300. If your mortgage costs have remained unchanged, you would now benefit with a positive cash flow of around £400 per month.
If you’re investing in creating retirement income, a capital growth strategy could produce rising income and positive cash flow exactly when you need it.
5. Flexible tax planning
With the main thrust of your investment producing capital gain, you can be flexible with your tax planning. As the law stands at present, should you sell your investment property you will be charged capital gains tax.
By deducting your sale price from the purchase price, you arrive at the capital gain on which tax is due. However, before your tax liability is calculated, your personal capital gains tax allowance (currently £11,100) is deducted.
If you invest as husband and wife, both personal allowances are deducted.
You then pay tax dependent on your personal income tax rate. The gain is added to other income, and if it is within the basic rate tax band, you will pay capital gains tax at a rate of 18%. Any gain above the basic rate tax band will incur capital gains tax at 28%. That’s a lot better than paying income tax at 40% or 45%.
In short, you can reduce your tax liability by investing in partnership with your spouse and then timing a sale to coincide with when you are paying tax at basic rate or lower.
Sensible investment and tax planning could keep thousands more in your pocket instead of putting it in the taxman’s coffers.
Comparing capital growth to rental yield
Two identical twins buy an investment property at the same time.
John buys a property for capital growth. He expects it to increase in value at an annual rate of 8%. The rental yield is 4%.
James buys a property for positive cash flow. It has a rental yield of 8%. Its value is expected to grow at a rate of 4%.
The twins each pay £400,000 cash for their investment properties. Both have plans to retire in 20 years.
After the end of the first year, they compare their gross total returns:
John’s property is valued at £432,000. He has received gross rental income of £16,000. His total gross return is £48,000.
James’s property is valued at £416,000. However, he has received gross rental income of £32,000. His total return is £48,000, the same as his brother’s.
After 15 years, they compare their investment property values and income again:
John’s property is valued at £1,864,383. He receives gross rental income of £74,575.
James’s property is valued at £876,449. He receives gross rental income of £70,116.
James’s property has produced better cash flow during the 20 years, but his brother’s rental income has now overtaken his own. Meanwhile, John’s property value is now more than double that of his brother’s.
Should you invest for capital growth?
For many investors, the choice between a capital growth property and one predicted to produce high rental yield is a difficult one to make. There are so many factors to take into account. These include:
- Your tax position
- Your marital status
- Your financial objectives
- Your cash position
- Mortgages available to you
It's just not a straightforward “yes” or “no” answer to a straightforward question. To discuss your investment objectives and create an individual property investment strategy based on these and your personal circumstances, contact one of our team today on +44 (0)207 923 6100. You’re only one chat away from joining thousands of other investors enjoying the benefits of property investment.
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