Both, Net Yield and Capital Growth, are important but not equally probable.
The total annual return of an investment property is made up of two components: the Net Yield and the Capital Growth.
Return = Net Yield + Capital Growth
You could get a 10% return in either of the following scenarios:
1. Yield: 5% and Cap: 5%
2. Yield: 6% and Cap: 4%
3. Yield: 4% and Cap: 6%
4. Yield: 8% and Cap: 2%
5. Yield: 2% and Cap: 8%
6. Yield: 10% and Cap: 0%
7. Yield: 0% and Cap: 10%
One thing we know for sure from day one is the Net Yield of the property (not exactly but close enough).
We know Yield.
Capital growth on the other hand is just an estimation. It could end up being 10%, 7%, 0% and even in some cases -5%.
We guess Capital Growth.
Most of us like to think that our investment property will grow annually by at least 7% if not more. That’s normal. We are only human. We expect +7% capital growth and close our eyes to the fact that it could end up being 0%. When instead we should be hoping for +7% but be prepared for 0%.
Hope for +7% capital growth but be prepared for 0%.
It would be common sense to focus on what we know and what we can control to maximize our return and minimize our risk.
We have limited knowledge and most importantly no control whatsoever over capital growth (renovations/improvements/additions can result in an instant boost of equity but they stop there and don’t continue annually and most importantly require more funding to begin with). Why place all our eggs in that basket?
We can fairly accurately estimate the net yield. We know for sure the yield component of the return we can get from our investment property.
Yield is like the salary you get from your job. You know how much you will get.
Capital growth is like the money you might make or loose in the casino.
Given this information, where would you like to be?
1. Yield: 5% and Cap: 10 to -5%
2. Yield: 6% and Cap: 10 to -5%
3. Yield: 4% and Cap: 10 to -5%
4. Yield: 8% and Cap: 10 to -5%
5. Yield: 2% and Cap: 10 to -5%
6. Yield: 10% and Cap: 10 to -5%
7. Yield: 0% and Cap: 10 to -5%
If you said 5 or 7… good luck to you… you will need it.
If you said 1, 2, 3, 4 or 6, good luck to you too. However you won’t need it. You’ll be fine either way.
What to take a way from this article?
1. Ensure a minimum return by focusing on the Net Yield.
2. Increase your chances for a potential maximum return by not neglecting capital growth.
All the best in your investing,