Rental yields or capital growth?
Your investment property will deliver a combination of two types of returns - regular rental income plus capital growth (an increase in the property’s value).
Yield focused strategy
The rent return is often referred to as 'yield', and is calculated by dividing the annual rent through the value of the property.
For example, a property with a market value of $500,000 that can be rented for $485 weekly - or about $25,220 annually, would have a gross (before expenses) rental yield of around 5% ($25,000 divided through $500,000, then multiplied by 100).
It’s useful to know a property's yield as it lets you compare the rent return between properties, and against other types of investments.
A focus on yield can be useful if you don't want to borrow heavily, or if you’re seeking a source of extra income to live on. In some regional areas, rental yields can be as high as 10%, which is an exceptional return. On the flipside, the long term price growth is unlikely to be as strong as a metropolitan property.
It's even possible to find 'positively geared' properties, where the rent covers all the expenses of the property with some extra income left over for you. By contrast, metropolitan areas - especially state and territory capitals, tend to earn a rental yield at around of 4% to 5%. This compares favourably with many cash-based investments, but remember you will also get the benefit of long term capital growth that adds to your total returns on the property.
Aiming for capital growth
The right property, in the right location, at the right price, has the potential to deliver rewarding rates of capital growth over time. If you’re aiming for capital growth, it’s vital that you can afford to hold onto the property until you see a substantial rise in the investment's value. For some investors this isn’t a problem because of the tax relief that comes with negative gearing, but do the sums to see if this applies to you.
Not sure which strategy suits you?
It helps to chat things through with your Mortgage Choice broker. Their expert knowledge of the local property market will give you plenty of food for thought.