How hard can property investment be?
If you have the money to buy an apartment or a house in a booming part of Australia, then surely it is just a case of parking your money in a good suburb and watching your asset grow?
And with unbelievable property growth in our capital cities – two years of double-digit home price growth in Sydney have heightened fears of a property bubble – property investment seems like a safe bet.
But, as most seasoned investors will tell you, it is a lot more complicated than that. And one of the biggest decisions an investor will (or should) make is whether to adopt an investment property strategy around high rents or to chase capital growth instead.
A tale of two strategies
It is extremely rare to find a property offering both high rental yield and high capital growth.
Why? Well, properties with excellent capital growth are generally located in blue chip suburbs where the prices paid for them are significantly higher than weekly rent.
For example, in the upmarket Melbourne suburb of Toorak, the average price paid for a two-bedroom unit is $727,000, while the average rent is a mere $451 a week, according to realestate.com.au data.
This gives a rental yield – the percentage rate of income return over the cost of the investment property – of 3.2 per cent.
High-yield properties (around 8-10 per cent) are generally in outer and regional areas, where the price paid for them is much lower. And, crucially, most are positively geared from the get-go. Pretty tempting, huh?
Why capital growth is king
Despite the immediate benefits of rent money in their pocket straight away, most property experts chase capital growth instead.
“It’s the question I get asked more than any other question when it comes to investing in property,” says investor and author of The Investment Property Plan, Stephen Zamykal.
“For me, the answer is simple – you have to buy for capital growth. People often think that investing for rental return in the outer suburbs, especially when they are starting out, is a good strategy.
“Because there is less competition from investors, the thinking behind this strategy is that you may grab a bargain. However, investing in property within the inner-city, say a zero to 10km radius of the Melbourne CBD, tends to achieve the best capital growth.”
Mr Zamykal argues that the figures speak for themselves.
He points out that a $500,000 property with a high-rental yield of eight per cent and lower capital growth rate of four per cent will be worth $1,053,425 in 20 years’ time, with a rental income of $84,274. But the same property with eight per cent capital growth rate and a four per cent rental income will be worth $2,157,851 in two decades, and by then will have an annual rental of $86,314 per annum.
“In 20 years’ time, by investing in the capital growth property, you have an asset worth $1.1 million more than the cash-flow property,” Mr Zamykal says.
“What is more interesting, in 20 years’ time, the rental income is higher on the property with more capital growth, because it is worth (so much) more than the cash-flow property.”
When rental returns work
There are times, however, when the rental returns strategy – by sheer necessity – trumps the capital-growth approach.
As property investor with Chicks and Mortar, Katie Marshall, will testify, some investors will not be able to afford the more lucrative capital growth strategy, which requires healthy financial reserves to hold a negatively geared property for many years.
“Capital growth could also take a long time if you are not market savvy, understand the property cycles and buy at the right time,” Ms Marshall says.
The rental strategy is suitable then for investors who otherwise could not afford to enter the market, although it is obviously not as successful in the long-run.
“Because they are generally located regionally, these properties could take longer to increase in value, if at all, and the amount of rental returns you receive from these properties could decrease if costs and rates rise,” Ms Marshall says.
“But if your income is on the low side and you don’t have spare cash to cover the holding costs on a property until it rises in value, then … rental returns would be a better option.”