Should you invest for rental yield or capital gain?
One of the biggest dilemma’s in property investing circles is whether you should invest for rental yield or capital gain. This is a debate that will probably never be won - it really does depend on your investment timeframe, your other income, cash flow and the amount of equity you have available, and most importantly your attitude towards risk.
This debate is often referred to as to whether you should invest for positive cash flow or capital gain. This obviously assumes that you’ve borrowed 100% of the funds to purchase the property, because if it was only a 50% deposit virtually any property will become positive cash flow.
Reasons to invest predominantly for rental yield
- It pays the mortgage. If your rental income pays for your mortgage and other expenses it makes it much easier to hold onto your investment for the long term, and you’re less likely to be forced to sell in a downturn.
- Banks like serviceability. When banks assess you for a mortgage they want to know that you can repay the loan over time. If you have a high rental income as well as your salary, the banks are much more likely to lend you extra money to buy more properties helping you grow your portfolio.
- Less expensive properties. Properties that have higher rental yields are often found in outer suburbs away from our capital cities where properties are often cheaper. This makes it possible to have a more diversified portfolio and to acquire your next property quicker as you need to save less of a deposit.
- Capital growth is a bonus. Capital growth rates are often lower in outer suburbs and can be more volatile depending on the local economy. If it’s not your prime investing purpose, then capital growth simply becomes a bonus.
Reasons to invest predominantly for capital growth
- It builds wealth. Capital growth is the real key to building serious wealth as it’s not taxed until you sell, and you can refinance it out to use as deposits on further properties. It’s much harder to save a deposit from rent when you lose half in tax.
- Banks prefer to lend on them. Properties that attract higher and more stable capital growth are often in more blue chip suburbs around our inner cities, making them less risky for the bank to lend on, especially if they are around the median price. If the banks are more confident, so should you be.
- Cash flow losses are tax deductible. Capital growth properties often have less rent, leading to a difference between the rent and the mortgage. These losses can be offset against salary income which is very appealing to higher income earners.
- More stable investments. Properties that are located in our inner cities are typically short in supply as there is no more land to build on and height limits have already been reached. There are also more people who want to be close to work and leisure facilities meaning demand is always building. That lack of supply and increasing demand gives a more stable investment that is likely to hold its value in the tough times and grow in the good times.