Investment Education – Yield or Growth: do you know the difference?

Deciding which property investment strategy is best for you

When you’re searching for the best property investment opportunities, your choice will depend upon several factors. Perhaps the most important of these is your property investment objective. Without knowing what you want from your property investment, how can you decide on the right strategy, and select the right property to buy?

In this investment blog, you’ll learn the difference between rental yield and capital growth. Armed with this information, you’ll be better informed before you start the search for the best places to invest in property UK.

What is a capital growth investment property?

If you want to grow your pot of wealth, perhaps the best way to do so is to invest in a property with potential for strong capital growth. That is, the value of the investment property is going to rise faster than inflation.

I’d define strong capital growth as being around 5% or 6% higher than inflation. That’s going to protect and grow the spending value of your investment cash. If the inflation rate is, say, 2%, I’d want a property investment made for capital growth to increase in value by around 7% or 8% or more.

What drives capital growth?

For an investment property to increase in value, there must be demand from buyers. This demand must outweigh supply. So, if you’re investing for capital growth you should search in an area where:

  • Investment benefits from the property fundamentals of shops, schools, transport links, major employers and major investment
  • Land is scarce, and developers are limited in the number of properties they can build

Other factors that might shape the supply/demand dynamic include average wages and savings in the area in which you invest. Property investment industry history shows that where income growth is above average, property values tend to outperform the average.

If you want to invest in growing your investment pot you should look for these capital growth areas.

What are the downsides when you invest in capital growth properties?

A capital growth property will often generate negative cash flow. What this means is that the rental income won’t cover the mortgage and other expenses of owning an investment property. Investors who buy capital growth properties know how negative cash flow could make you a wealthy property investor.

When you invest in negative cash flow property, you must subsidise your investment with other income. If interest rates rise, your negative cash flow position could deteriorate. It will mean you need to put more of your money into the investment.

What is a high yield investment property?

A high yield rental property generates positive cash flow. The rental income is more than the mortgage and other costs. Each month, your investment pays you income.

How high the rental yield needs to be to be defined as high yield depends upon interest rates. Generally speaking, a gross rental yield of around 8% to 10% would be considered as high yield. If interest rates are around 4%, a gross yield of 8% will clear you a net 4% before other costs.

What drives rental yield?

In areas where people prefer to rent, the demand for rental properties is higher. It may be dictated by the type of work available (for example, seasonal work in tourist areas), or relatively low wages and savings.

A shortage of rental properties will also put upward pressure on rental values.

If you want to benefit from regular income, or cannot afford to subsidise a negative cash flow property, then a high yield investment property could be the right strategy for you.

What are the downsides when you invest in high yield properties?

Over a longer period, it’s unlikely that your wealth position will increase as fast as it would if you invested in capital growth properties. You could also find that your income tax bill is higher. It is especially so with the phasing out of higher rate mortgage interest tax relief.

Cash flow would be harmed by rising interest rates, though the positive cash flow does provide a cushion against this.

Other things to consider before investing in property

You should now have a better idea of what investment strategy is best for you. However, you should also consider your tax position and longer-term goals.

If you want to sell your property in the future, high capital growth will create a bigger capital gains tax bill.

If you’re a higher rate taxpayer, high yielding investment property will give you a bigger income tax bill.

You can mitigate some of the risks by taking advice on matters such as tax, mortgages, and investment property management.

For example, it’s possible that you could reduce your tax bill by investing in UK property investment opportunities in different ways. You could invest in joint names with your spouse, as a partnership, or as a limited company.

By taking advantage of the benefits of using a buy-to-let mortgage broker, you could fund your property investment with a fixed rate mortgage, which eliminates the risk from rising interest rates.

Summing up your strategy options

Both strategies could help increase your wealth. If you’re chasing capital growth, you’ll probably need surplus cash flow to subsidise the difference between rental income and costs.

Holding a high-yield investment property is likely to give you a second income. You could save some of this income to create a surplus for emergency maintenance needs, or to subsidise an unexpected void period.

Whichever strategy you decide is best for you, they have both been proven to create wealth. Whatever your financial objectives, property investment is a proven way to achieve them.

What is the best strategy for you?

We meet with all types of investors, including beginners, career professionals, and foreign investors. When we meet, one of the main topics of conversation will be to help you understand which investment strategy will help you meet your financial objectives fastest.

Contact one of our team today on +44 (0)207 923 6100, and arrange a meeting that will establish how you could invest in property to create the lifestyle you want.

Live with passion

Brett Alegre-Wood

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