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Ben Kingsley Blog post by Ben Kingsley

Which Property Investment Strategy is Right for you?

Those who follow property investment would know that there are two main groups of investment strategies – Growth vs Yield – those strategies that chase growth and those that chase yield.  It is all well and good to have these debates as magazines, blogs and TV shows need content and this always makes for a good read, but aren’t we missing something here?

When you realise that just like every other type of investment property offers investors capital growth and Yield (rent) returns, the conversation must move to the mechanics associated with each type.

Let me explain each of these property investment strategy……

 

Capital Growth Property

For capital growth property to continue growing in value they need an underlying demand and also an equally important above average income from consumers seeking to buy these assets.  Think of it like this, let’s say 1,000 couples had household incomes of $100,000 each and 1 particular couple had an income of $150,000.  Based on the $100,000 household income the 1000 couples had borrowing power capped at $500,000.  Then if you factored in them bringing savings of 10% to the purchase, they can afford to buy property worth $550,000.

Yet, for the couple of $150,000 they have borrowing power of $650,000.  Now assuming they too have 10% savings to go towards the purchase, they technically could afford to purchase a property worth $715,000.  BUT, given there is no competition at this price point and because value is set via the forces of supply and demand, no property would ever reach $700,000 as there is insufficient demand to push values higher.  Hence the reason income growth and borrowing power are critical in supporting property values.

So areas where the location appeals to consumers and income growth is above the average, the value of property will continue to outperform over the longer term thus, we call them capital growth areas / properties.

 

Yield Property

On the flip side, yield property – i.e. properties that attract above average yields do so because of only two things.  There is a shortage of shelter within a location, pushing rents higher and secondly the consumers within the market have determined they would either prefer to rent (mining towns are classic for this, as they are usually remote locations with very little lifestyle benefits to stay long term) or they simply cannot afford to buy in that location.

Now the important thing one needs to remember here is that, if the market offers shelter whereby the cost of repaying the loan is the same as paying a landlord rent then consumers would more than likely respond to buying instead of renting.  Only problem is that in a free market this wouldn’t occur and in the real world doesn’t happen.

Why? Well, because demand to purchase outstrips supply, as the underlying land in which the property is on is finite (limited).  So you get a situation for capital growth properties, where renting in a area is more often than not a lot cheaper than paying a large mortgage off.

 

Which one do you choose?

Therefore in understanding this, as property investors we now know that if we are chasing growth properties, we are the ones paying the higher loans and the rental returns are initially significantly less than the income our investment produces.  Meaning we need to cover this shortfall with our own surplus cash.  Now you might be thinking where is the payoff for such a strategy? Over time the value of the property increases significantly and sure enough, as the value of the property grows the rent you can charge for people choosing to live in the prized location you have your property in, also increases.  And on the other side of the coin the debt doesn’t increase, so over time the property turns from a negative return to a very good positive return and ultimately an excellent passive income in retirement, which should have been the initial plan.

But what if you don’t have a significant surplus household cash flow right now?  Should that stop you from investing?  No, it shouldn’t.  Too often people think, “ I’ll just wait until the household income improves so I can buy a growth property”. But the reality is these people often then start a family and that planned strong surplus never comes, so they never get an investment property that will help them build wealth.

The solution for these clients is to focus on a yield strategy for their first investment.  One that doesn’t hit the hip pocket too much each month.  Furthermore if the household surplus income does pick up then potentially the next purchase could be a growth property.  I foot in both camps!

However a word of warning with yield locations and property, very few traditionally high yield property, outside of the mining town boom and bust cycles, deliver strong capital growth.  So just picking any high yielding property or area is madness.  It’s a real science to find the right locations that are going to do well for you.  Secondly, don’t fall for the trap of guaranteed rental yields or new properties with really big depreciation right downs.  They often underperform the market in a big way.

In summary my message is an important one and that is; your personal financial circumstances should determine your strategy, and NOT the other way around!  The great news is that both are wealth building strategies and that means opportunity for all types of investors.

Remember, Knowledge is empowering if you act on it.

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