The secret to successful property investment always combines income and growth
I recently spoke to a property investor who was having a pretty tough time. He owned a couple of buy-to-let properties, but they were both underperforming. He told me that when he invested, he did so because of the incredible rental yield each property promised. Now, however, he has discovered that the value of the properties had fallen. I had to explain the trade-off between capital growth and rental yield, and why you shouldn’t consider either in isolation when you are assessing property investment opportunities.
Don’t be fooled by average yields
The average rental yield in the UK is a little over 5% (Global Property Guide, 2017/18). However, this masks wide regional differences and even greater differences within those regions. For example, in the North West, average gross rental yields are around 7% to 8%. But within this region, and even in neighbouring postcodes, rental yields vary by a large margin. As an example, in Preston:
- The average rental yield in the PR1 postcode is 10.04%
- In the neighbouring PR5 postcode, the average rental yield is just 4.02%
In London, average rental yield in the E1 postcode is a miserly 2.93%. Just a couple of miles away, in E20, the average rental yield is above 6% (TotallyMoney rental yield map).
If you look at rental yields in isolation, as the investor I met had, you’d be tempted to buy only in the high-yield locations. But yield alone doesn’t tell the whole story of return on investment.
The balancing act of yield vs capital gain
Two of the three ways to make money from property investment is by rental income and capital gain. Let me tell you this now: there is usually a trade-off between the two. (By the way, the third way to make money from property is remortgaging.)
- A high rental yield will help you cover the costs of owning buy-to-let property, and, hopefully, make some money on top.
- On the other hand, a higher capital gain will enable you to build your wealth pot faster, and take advantage of capital gains tax allowances.
Upmarket areas tend to be in high demand. It pushes capital values higher while keeping rental yields low. The reverse is true, too: where rental yields are high, capital growth is usually lower.
Take our examples in Preston. Over the last year, the median asking prices for properties in the two different postcodes have:
- Decreased by 5% in PR1
- Increased by 19% in PR5
If you had bought in PR1, your cash flow would have benefitted from the exceptional 10.04% yield. However, this is eaten up by the underperformance of property values in that postcode. Over the year, were you to sell, you would have only made around 5% (10% yield – 5% capital loss).
Meanwhile, if you had bought in PR5, while your income would have been lower, your capital gain means that you’d have a paper profit of more than 20% in a year.
So, what’s most important: yield or growth?
Most investors want to profit from both rental income and capital growth. To decide which is most important to you, you should consider your long-term aims and short-term cash flow.
If you want to build a pot of wealth to leave to your loved ones, then it’s likely that capital growth is most important. You may have to accept a lower yield to achieve this, and this may mean that you must top up a negative cash flow with money from other resources.
On the other hand, if your main goal is to create a passive income stream, then capital growth becomes less important to you. In this case, you would weigh your investment towards rental yield and positive cash flow property.
Of course, the perfect property investment would offer a high yield and a strong potential for capital growth. When you are considering which location to buy in, and what property to buy, you should consider your investment objectives and seek to achieve them by a combination of both rental yield and capital growth. Never put all your eggs in one basket.
To discuss your investment objectives and build a property investment strategy to achieve them, get in touch with Gladfish on +44 207 923 6100. We’ve helped hundreds of investors just like you achieve their long-term income and growth goals, while maintaining their lifestyle in the short term.
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