Yield vs. Capital Growth

[Luv2Travel]

I read a lot of comments on here about buying high yield property vs. high growth property. I'm in a position where I have just bought my second IP which is negatively geared and wouldn't be in a position to buy another property any time soon, particuarly if it too was going to be negatively geared. However I am buying for the very long term (i.e. plan to retire on the rents I generate from a few properties I plan to buy and pay off) and so have been crunching some numbers.

I understand why people buy high yield (which often results in lower growth as they tend to be more regional properties), as it allows better cashflow and allows them to buy more sooner. However, if one is looking to buy a few properties for the long term, I'm not so sure about high yield. Those who do buy for this reason, is it a shorter term investment plan?

Obviously, this is a very generalised scenario, but some numbers I put together are:

Example of two options today:

1. Buy 2 x $200K regional properties with a yield of say 7%. Let's say they have average capital growth of 4%. In 20 years time, the properties are then worth $876,449. Yield of 7% on that is $61,351.

2. Buy 1 x $400K property in a capital city with a yield of say 4%. Let's say it has average capital growth of 8%. In 20 years time, the property is worth $1,864,383. Yield of 4% on that is $74,575.

I know there are many variables and assumptions in the above figures. For someone who wants to build a massive multi million dollar portfolio, I can see why yield is highly important in the short term for cashflow and borrowing capacity, but for someone who just wants a few properties, to be able to retire on rental income, is buying for yield a little short sighted?

Whilst the yield % maybe less, the capital growth is increasing faster, which is likely that the rental $ is increasing faster?

I'm not suggesting one way is better or more correct than the other. Just interested in people's thoughts as to why they choose one method over the other.

 

[Nathan]

Goood questions, however I see there is a missing key.

Its good to have both metro and regional proeprties.

One shouldnt buy anything at all regional or metro with sub 7% yield unless it has a substansial equity play straight off the cuff.

The rates of growth on regional vs metro are very similar if you buy in a larger regional purchase.

If someone buys 1 property which is $600k rents $400pw its neg geared by approx 500pw or 26k pa.

Now if someone buys properties within fringe of the city e.g. 30-40km out for say $250k each, but negative geared by $100pw, they could hold 5 which is $1.25mill worth of holdings. so for same cashflow could hold a larger ammount. Now can rent increase by $500pw on the 600k joint? very difficult. If the rents on the cheaper ones increase bite size of say $100pw that means the holdings are neutralised by a swoop of rent increases.

Now lets scrub that off the board and look at growth of properties. I dont do charts graps etc, but if you look at the larger regionals, the prices have not always been what they are today. The cashflow is stronger, and gies you opportunity to purchase a lot more real estate for same inital capital.

It is important to have a mixture, and important not to speculate however I am strong believer that cashflow is very important to sustain a healthy portfolio. If it costs nothing to hold or very little you can keep progressing. Thus giving a lot more options. Guess it depends how aggressive each investor wants to be with their own portfolio.

Hope this gives a bit of clarity.

The numbers of growth are unreliable as 4% is just an assumtion same as yeild and same with yeild grown being left out of the equiation...

Goodluck

Nath.

 

[grossreal]

hi
if you went for dual investing then the following happens
and the numbers are a bit rubbery as you have to setup a structure to do it
but say you have a neg property costing 50k per year
and you had a comm generating after tax net 50k you are in fact neutral.
now the comm usually is high yeild but usually low growth(yes very generic as there is grow in this market but let work on no growth)
the negative is where the growth is
and you leave these two to go for 5 years
then revalue
at this stage its been neutral all along but the negative has doubled
so you pull out that equity or (leave it and equise against it) and buy another comm
again you get a high yeilding comm and work out how much spare cash it will have
you then find a neg property and start the same process again
at this stage you should have 4 properties two neg and two pos and all neutral.
keep doing this and you will amass a very large portfolio.
now what to what for
if the negative does not have capital growth but goes backwards

then sell the negative property
and sell 5% or 10% above your cost (to cover costs)
now the comm is still positive so you can build a war chest to go back ionto battle
what is the comm goes west
now you have a problem
because you have a negative property and your cash went west this causes a big problem
so
thats why its a structure not something you just do out of hand
and you have to have safe guards in place and that where a structure person organises and that bit is not for a board sorry about that
this is not any form of investing
but is some thing to think about
just an idea for you

 

[SeafordSunshine]

Yield vs Growth... I went for growth!

Hello Biggles,

I could afford to pay the mortgage, with money from elsewhere. I knew Being a girl who didn't Ever bother with super, who lost most of it in fees.... that my IP was my super. I needed to do something Serious and Sensible for my old age... so I went for capital growth, and it has seemed to work!
Best of luck with living off the rent! I would love to know how much I required to live off in my retirement, but I am just not into the maths
Cheers
Seaford Sunshine

 

[grossreal]

hi SeafordSunshine
the answer is 45k
thats what 95% of australians have to live on after 65 under that and you go on the pention and that I think is 35 k
now the problem is you do have to spread
its not just as simple as investing
I have spoken to people with 3 mil held in trusts at the moment living on under 17k per year
they can't get the min wage because they have 3 mil in investment
this is a huge problem
we have starving people over 65 that have no safety net because their net worth is over 1.5 mil have a chat with life line
so you need to have a structure if they had a structure they would not have this issue
the answer to your guestion is 45 k but the real answer is get a structure that will give you 45k from many streams of income
thats as best I can give

 

[brendio]

The result in your example comes straight out of your assumptions:

1. ... yield ... 7%. ... capital growth ... 4%. (7+4=11%)

2. ... yield ... 4%. ... capital growth ... 8%. (4+8=12%)

A simplistic formula for total yield is:

Total yield = rental yield + (annualised) capital growth

In your examples, case 1 has a total yield of 11% and case 2 a yield of 12%. What happens when you run your examples again with 5% growth for the high yielder? Your yield in 20 years time comes out the same! ($74k on property worth $1.06m).

So the real question comes down to examining those assumptions. Unfortunately, while you can easily calculate the rental yield, the capital growth is a known unknown (we known that we don't know what it will be; maybe we can do backtesting with historic data?).

Now a real-life example should tax into account tax, which will obviously differ according to individual circumstances. But anyone earning above the tax-free threshold will have to pay tax on the rental yield component. They will also pay tax on the capital growth eventually, but only when they sell, and this can be delayed with a buy and hold strategy, so this contingent tax liability from the unrealised capital gains on the high growth property can continue compounding away and earning the capital growth component on the sum owed to the tax man (eventually). Depreciation works in a similar way (decreases tax now, increases CGT on sale). Add in the 50% CGT discount, and the high growth property starts to really shine.

Note this is all based on the assumption of identical (pretax) total (rent plus CG) yields. It comes back to the validity of this assumption. If you can find a property that's running yield makes up for its lower growth and less favourable tax situation then I still think it could be a better investment. But all things being equal, so long as you can service high growth properties, I think they are generally a better investment from a post-tax perspective (might be different in an SMSF in the pension stage).

I think you could have similar discussions about shares (growth versus income). Each have their place for different investors.

 

[Intrinsic_Value]

maybe you need to create some simplistic ratios for the property market.

A couple of useful simplistic ratios i use for the stock market to compare 'apples' with 'apples'

(Dividends+ EPS Growth)/PE

(Dividends + sustainable growth factor)/ discount rate

In otherwords translated into the property market, its not just yld or capital growth, but what is the sumation of the two.

For example:
Property 1: yld=10% no growth.
Property 2: yld=5% + 4% growth

Which one is better?
.....
.......
.........

To answer this you will need the final component, selling price of the property.

But at least it gives you a starting framework.

However like all simplistic forumulas they are only a guide.

Its the artistic investor who creates winning solution.

 

[BayView]

For example:
Property 1: yld=10% no growth.
Property 2: yld=5% + 4% growth

Which one is better?

For me; property 1, x ten of them.

Of course; we all like growth, but most people are investing with loads of borrowings, so the smaller yield slows them right down, and can even make their cashflow worse in many cases.

They soon get disillusioned and hate property investing; especially when they keep getting emails and phone calls from PM's who are reporting on yet another complaint from the tenants about something or other.

 

[Bill.L]

Hi all,

These debates about high yield zero growth vs low yield high growth pop up all the time. What I would like to know is where is one, just one property within 50 km of a town of 10,000+ that has shown no growth in the last 15 years?? I contend they don't exist.

bye

 

[Luv2Travel]

Thanks for all the responses. I can definately see the advantage for high yield, especially for someone like Nathan who has many many properties and continues to build his portfolio. I guess I'm trying to work out what is best for myself, I don't want a massive portfolio. Just a handful of properties that will give me enough rental income to live off in my retirement - even allow for a semi early retirement. I've accepted working full time until I'm about 50 (so still have 20 years for capital growth benefits), so will have PAYG income to support negative gearing if it means a better outcome in the end. Certainly something to think about over the next couple of years about where to go next. IP2 hasn't even settled yet, so just planning for my next move.
Might look into one or two higher yield properties though, to give me some diversity.

 

[Dazz]

I don't want a massive portfolio.

Why not ??

I've accepted working full time until I'm about 50 (so still have 20 years)

Why ??

 

[Bargain Hunter]

It is interesting that the usual comparison is if I had 1 x 400k property or 2 x 200k properties.... but the truth is very different.

There is a limit to how many negatively geared properties one can afford to buy and hold. This is due to there only being so much spare cash to service the loans, you will have reduced serviceability so will find it difficult to get another loan for sometime, which is going to be reduced, and the time it takes for the property to become CF+ or neutral means it will be sometime before you can buy the next one.

This doesn't consider the opportunity costs and this is where the if I buy 1 x $400k .... comes undone. While you may be able to buy two negatively geared properties worth $800k, you could have purchased five cheaper properties worth $1M which put money in your pocket on a weekly basis.

If you want to build a portfolio and you have limited income then the servicability needs to come from somewhere and a few CF+ properties will not go astray.

Regards

Andrew

 

[BayView]

Hi all,

These debates about high yield zero growth vs low yield high growth pop up all the time. What I would like to know is where is one, just one property within 50 km of a town of 10,000+ that has shown no growth in the last 15 years?? I contend they don't exist.

bye

of course.

It's an old wives' tale that regional property has high yield and no growth.

 

[Dazz]

It's also an old wives tale that you need to go out to the regional properties to extract a high yield.

High CG and Low yield - no thanks.

High yield and Low CG - no thanks.

Low yield and Low CG - popular, but no thanks.

High CG and high yield - the only time it's a yes.

 

[Luv2Travel]

Good questions Dazz, maybe I will re-assess at some point and decide I do want to and can retire earlier with a massive portfolio.

I'm still in very early days of investing (IP1 last year, IP2 this year). In order to start, it's good to have a plan and my plan at this stage is to have about $1.5M worth of investments (in today's $) when I retire (plus my PPOR). I'm just not entirely sure yet as to what will make that up. I'm sure my plans and goals will change many times before I achieve that end result and like hearing what others are doing successfully.

 

[Dazz]

It sounds Biggles that you are making good progress. That's expected, as the banks usually give you an easy run for the first few, until they start demanding you jump over a few more hurdles.


If you have 20 years up your sleeve, I would suggest that your 1.5m goal may seem very large and imposing now, but perhaps you are looking at it thru maybe 3 or 4 years goggles. Pop on your 20 year goggles, and if you play your cards right you'll soon discover that your goal is underwhelming.


You're off to a good start anyways, so keep it going !!

 

[our obsession]

Biggles, gotchya something you may find of interest, pm'd you.

I have learnt to "buy well"-for my circumstances, building a little Obsession empire of Appreciating Assets. Of which will leapfrog me into other *"stuff".

* To be researched and decided upon yet.

 

[.toe]

I dont understand why everyone is so prepared to argue over this. The positives and negatives of yield vs growth are clearly dependant on an investors individual circumstances. If you want proof then download Jan Somers' software and run the portfolio projections using variations on initial capital, marginal tax rate, growth, yield etc. Make sure to get real world examples of growth vs yield. It can save years making these decisions.

For me a portfolio thats slightly negative gives the best growth over time. If growth is too low then I cant afford to buy more in growth areas. If yield is too low I cant afford repayments on new purchases. But income and equity levels (and tactics) will change this.

Somersoft Property Investment Analysis (PIA) Software

 

[Aaron Sice]

another forum member and i are putting deals together now that generate 9-15% yields and 30-50% equity immediately - in one town with a tenement, we can double our money overnight.

the best bit is, the demand is there but the GFC has eneded a lot of investment in these areas. takes a while to find them, but when you do....well....

potential for CG is not as fast paced at upper end stuff, but then, ongoing CG is all perceived value anyway. the GFC took care of most of that.

but the potential is there. just think outside the box and you can make a lot of money in a very short period of time, and if you can't refi/crystallise your profit, your holding costs are less than below market rent.

+1 for exit strategies.

 

[D.T.]

I dont understand why everyone is so prepared to argue over this.

Everyone likes to believe their own way of doing things is the 'right' way, whether the topic is investing in property or eating weetbix.