Rental Yield vs Capital Appreciation: the Discussion Which Never Ends!

We all know how blog titles work – intriguing, engaging, even enraging, however in this piece we’re not really trying to do any of those things. The fact is that the balance between yield and capital profit is never irrelevant.

We reckon that anyone who reads our blogs has sufficient nous to know that it’s not an either/or argument so we’ll not pretend that it is. Rather we’re going to take a look at why getting the balance right matters.

We’ve years of experience serving the buy-to-let and property investment sector, so we’ve had the opportunity to see what works, when and for who.

Property vs other investments

Finding a definitive answer to the question of property or stock market is about as easy as catching eels with your thumbs tied together! The answer will very much depend on the economic situation at the time of asking.

That said, there is a long-standing acceptance that over the longer-term, property is a very solid investment which is capable of delivering excellent returns compared to all other options.

After all, everybody’s heard the phrase: “You can’t go wrong with bricks and mortar”!

Capital appreciation

Capital appreciation is the long-term game in property investment, essentially wagering that over a period of years, the value of property will increase sufficiently to deliver a sizable profit when finally sold.

Although not the exclusive purview of smaller investors, it is true that many who rely on capital appreciation will own only a few properties. Rental income facilitates their investment, and may generate some profit.

However, their principal expectation is that when they come to sell their properties they’ll realise a substantial profit which will allow them to afford a more comfortable retirement.

Pros and cons of capital appreciation

Pros

• There is the potential for a very substantial return, especially over the medium to long term.
• A long-term investment tends to be less vulnerable to the whims of the property market.
• You can get lucky and generate considerable equity in the short term if the market is on the up.

Cons

• While short-term gains are possible, you should anticipate committing to a long-term strategy to realise the best return on your investment.
• Often more expensive properties deliver better long-term growth, so expect there to be more competition. Your initial investment may be relatively high.
• With more expensive properties you’ll face higher costs in terms of borrowing (if relevant) and Stamp Duty or LLBT. You’ll also face additional dwelling supplements which, being a percentage, increase along with the purchase price.
• When you finally come to sell the property, you’ll have to pay Capital Gains Tax (CGT) on the profit you earn from the sale.

Income from rental yield

Yield is the expression of rental income for a period of one year, divided by the purchase cost of the property times 100 to give a percentage. For example 12,000/240,000×100 = 5%.

According to NatWest, anything over 6% can be regarded as a “good yield”, above 8% is seen as “very good”.

It is often used as a benchmark to determine whether a property has real investment potential or not.

Clearly the higher the rental income and the cheaper the property, the better the yield, which is why when we look at various areas of the country, it’s often areas with lower property prices which deliver excellent returns.

Concentrating on maximising yield will generally reduce the initial investment costs and, voids not withstanding, deliver regular income. Additionally, even cheaper properties appreciate in value, albeit at a lower rate.

Pros and cons of rental income

Pros

• Since yield is affected by purchase price, with careful buying you can reduce your initial outlay considerably.
• You’ll earn regular income from rents, and should you choose to buy with a tenant in situ, you’ll start earning from day one.
• Judicial management of your rental income can reduce your mortgage, increasing the amount of equity in the property.
• Lower property costs translate to lower Stamp Duty/LBTT costs, lower mortgage costs and lower ADS costs.

Cons

• It’s highly possible that a strategy which favours yield will result in buying properties with lower long-term capital appreciation prospects.
• Rental income isn’t guaranteed, and you will almost certainly encounter void periods where you have no tenants. Unfortunately your costs won’t take a similar hiatus.
• The income you derive from rent is taxable just like any other source of income. Operating as a limited company may be advantageous, but this will depend very much on your particular circumstances.
• Capital gains tax may well apply to any profit resulting from the eventual sale.

Advice from the property pros

When trying to decide between rental yield vs capital appreciation as the basis for your investment strategy, it’s important to realise that both are valid.

Indeed, there is a strong argument for saying that the best overall strategy is a combination of both, and the real decision is the degree to which you bias your investments in one direction or the other.

And of course, it’s nuanced…

Is it, for instance, worth investing in a property which consistently delivers excellent rental yield, but demonstrates little or no capital appreciation? What if it actually makes a loss when you sell?

On the face of it, that’s a bust, but if you calculate the profit from the income over the years and set that against a small capital gain or loss, you may find that the overall return was in fact well worth the investment.

Chris spoke about this recently; “An investor must be clear on how much the property needs to yield over a 5 or 10 year period for the lack of capital growth to be a non-issue. Even if there is some level of capital depreciation… it doesn’t matter”.

The underlying truth here is that property investment is seldom a ‘get rich quick’ scheme, and is better approached as a medium to long-term commitment. You could make a lot of money in a short period, but it’s less likely.

Finding the right balance between yield and appreciation has the benefit of generating income and growing wealth, which is one of its great attractions and sets it aside from other investment options.

In summary…

Since we last wrote about rental yield vs capital appreciation some years ago, the fundamentals haven’t changed.

Capital appreciation still requires a medium to long-term approach as this is necessary to ride out any periodic fluctuations which are an inevitable feature of the property market.

Rental income is less reliant on a long-term approach and can be a lower-cost investment for the landlord, but can present greater risks in terms of voids.

That said, over the longer-term such variance may even out, delivering consistent returns.

All of the above illustrates why we are always keen to speak to potential investors, to find out what they hope to get from their investment. It also gives us the chance to explain the pros and cons of the two approaches.

Generally most clients have already done a fair bit of research before we speak to them, which makes it easier for us to add our experience to the mix and help them find the right solutions for them.

If you’re looking to begin investing in property, or already have experience of the sector and are looking to expand, get in touch and we can discuss how best we can help you.

Thanks for reading this far, we hope it’s been helpful.

Written by Ross MacDonald, Director of Sales & Cofounder of Portolio

Get in touch on 07388 361 564 or email to [email protected]