Rental yield vs capital growth - which is best for investors?
Cath, Assistant Lettings Manager, takes a look at the differences between rental yield and capital growth when it comes to a property investment...
Estimated reading time: 4 minutes.
For those who are new to the property market or who are thinking about diving into their first property investment, you’ll quickly realise there are a host of financial considerations. New property investors who are entering the landlord world tend to only think about the rental income they can achieve, or the way in which the property should increase in value over time.
They rarely consider what it is they are actually looking for long term - is it a high rental yield or capital growth?
Now, of course, the obvious answer is both, and in some cases a landlord can certainly achieve both.
However, investors may also quickly find that many properties typically lend themselves better to one over the other. This is why it can be a good idea for a landlord to consider their long-term property investment strategy and purchase rental properties that match that outlook.
So, let’s take a look at what rental yield and capital growth are, and try to better understand why we might want to choose one over the other.
What is rental yield?
In simple terms, the rental yield is the amount of money that a landlord can expect to make on a property through rental income.
To find the true profit, the landlord will have to measure the difference between overall costs and the rental income received. The difference between the two will be the profit.
Below is an example of a how a landlord can work out their rental yield:
Let’s say a landlord purchases a property for £150,000 and generates an annual rental income of £9,000. This will give the landlord a rental yield of 6% (9,000 ÷ 150,000 x 100).
To work out how much actual profit is achieved a landlord will need to subtract the total expenses from the annual rental income and divide this by the cost of the property. This figure can then be multiplied by 100 to produce the net rental yield percentage in terms of profit.
So, using the above example, typical total annual expenses of £2,200 for taxes, mortgage, insurance, repairs and fees would produce a net rental yield of 4.5% (9,000 - 2,200 ÷ 150,000 x 100).
What is capital growth?
Capital growth is the increase in value of the property over time, so we can consider capital growth a longer-term investment strategy.
For example, if a landlord purchases a property at £150,000 and sells it 10 years later for £250,000, the property would have achieved £100,000 in capital growth.
Read: Buy to let jargon explained - an A to Z
Which is better - rental yield or capital growth?
Unfortunately, it’s not quite as straight forward as figuring out whether targeting rental yield or capital growth is the best. The property market is different all over the country, and even from suburb to suburb. Capital growth and rental yield percentages are likely to be very different when comparing properties in Cardiff to a small village in Rhondda Cynon Taff.
Higher house prices in larger cities can often mean that uber attractive rental yield investments are more difficult find for the average landlord, with true yields typically in the 3-5% range, but the consistent capital growth in most cities means the overall value of the property can perform very well over the course of several years.
Meanwhile, other properties may command very attractive rental yields between 5-10% or more but may suffer from lower capital growth meaning over several years the actual value of the property increases a lot less.
With that said, there are always properties that aren’t so typical!
Thinking outside the box
To achieve a high rental yield around the 10% mark in an area of high capital growth means a landlord often needs to think outside the box and be extremely savvy. This could mean converting a house into an HMO, for example. While achieving high capital growth in an area that typically grows in value a lot slower could mean purchasing an entire renovation project and carrying out the work to a strict budget.
So, as you can see, the case is often that properties offering higher rental yields tend to deliver smaller capital growth, while properties with lower capital growth can often offer higher rental yields.
Read: Is an HMO property a good investment?
There are most certainly properties that go against the grain. Some properties may offer both an attractive yield and high capital growth, and some may offer very low rental yields and also low capital growth. It all comes down to a landlord doing their research of the property market and the local area and understanding exactly what it is they hope to achieve from their property investment - be that short term or long term.
Whether you’re an experienced landlord or thinking about entering the buy-to-let market for the very first time, our seasoned team of letting agents here at CPS Homes in the heart of Cardiff are here to help. For advice and guidance with your property investment don’t hesitate to check out our landlord guide and get in touch to discuss your situation by calling 02920 668585, e-mailing enquiries@cpshomes.co.uk or pop in branch to see us.
