Making a start in property investment can be nerve-wracking. There are so many terms to consider through this journey that the average Joe may be unfamiliar with. Two of those terms that are integral to understand are capital growth and rental yield.
Some of the common questions asked surrounding these two terms usually start with:
- Which should I focus on more?
- Will there be an immediate return on investment?
- Or, is it more important to look to the future?
However, it’s a little more complex than one being better than the other. It oftentimes comes down to personal circumstances as one money making strategy might not work for all.
Capital growth and rental yield are both some of the most crucial factors of property investment success. The property industry’s lingo can often come across as a little intimidating. However, believe me, it is actually far simpler than it seems. By expanding your real-estate knowledge, you’ll be able to make the best money-smart decision for you.
This article will help calm some of your anxiety surrounding property investment! It will break down and explain in detail what capital growth and rental yield are and how to calculate them.
What is Capital Growth?
Capital growth is also referred to as capital appreciation, and this is often the way that most people look to make money from their properties. At its most simple level, capital growth is the increase in the value of something over time.
In theory, if you buy a property for £200,000, in 5 years you could sell your property for £250,000, depending on economic factors in the UK. With this example, you would have profited £50,000.
Studies show that the UK property market has been on an upward trajectory for the best part of ten years, and aside from momentary dips, those who purchased back in 2011 may have seen considerable capital growth on their property investment.
Capital growth is something that every property investor should keep in mind when it comes to investing in property. Making a wise property choice ensures that you can get the most out of your investment.
The obvious thing about capital growth is that you can’t expect to have money just by sitting on your property investment forever. In order to see that return on investment (ROI), you’ll need to complete the sale of the property.
That being said, choosing to profit through capital growth means that it is not a passive means of income and it is not an immediate profit. It is not something one should rely on for a huge pay-out right away – it is an investment in your future more so than anything.
Can I Calculate Capital Growth?
Capital growth is a relatively speculative figure. It can be hard to pin down an exact value for your property because it can be so dependent on external factors like the housing market and depreciation. So, while it is possible to calculate a ballpark figure that you can work with, it is important to note that it is incredibly subject to change.
To calculate the percentage of capital growth, follow these simple steps:
Step 1: Work out the difference between the price you paid for the property and the price you are reselling the property for
Step 2: Divide your profit by the original cost of the property
Step 3: Multiply the answer by 100 to get the percentage.
Here’s an example is broken down for you:
- Original cost of bought property = £200,000
- Current value of property = £250,000
- Profit = £50,000
- Divide profit (£50,000) by original cost of property (£200,000)
- Answer = 0.25 multiplied by 100
- Answer = 25%
The capital growth of your property has grown by 25% over a period of [x] amount of time.
There are also great tools online that can help you work out capital growth. For example, you can use a chrome extension called Advanced Property Insights. This works on many mainstream property websites and shows you deeper insights into the RIO for different properties.
In terms of the optimal range, there actually isn’t really a ‘good’ percentage of capital growth, because any increase is beneficial. Although, if you were to consider price growth over the past 10 years, the average annual price increase works out at around 4.14%.
How Can Capital Growth Increase?
There are a few ways in which the potential capital growth of a property can increase. These include:
1. Increase in the property market.
This is the most hands-off approach to growing your properties capital. You don’t actually have to do anything at all to the property itself. It is just a case of holding off on selling until the market value increases. You can make quite good money from doing this.
However, a downside to this method is that it is all about timing. Property values cannot always be guaranteed to rise. If this is the method you choose to go with, it is imperative that you consider the external factors that may increase the market value over time. These are things like high growth areas, good transport, or local investment.
2. Improving the property’s value.
You can improve your capital growth by making your property more valuable. This can be through small scale renovations, such as replacing appliances or updating a room or it could even be something as simple as getting a better real estate agent to sell the property.
You could also have better marketing for the property or better photos on the advertising. This makes it look more valuable and entices more viewings and increases the potential for selling.
3. Buying the property under market value.
Oftentimes, homeowners decide to sell their property due to personal financial circumstances. Therefore, you may be able to bargain yourself below the current market value so the property owners can get a quick sell. As you would have scored yourself a great deal buying for less than its market value, you’ve already made money on top of your purchase.
4. Through development.
You can greatly increase your capital growth through major renovations or constructions. For example, this could be something along the lines of buying a plot of land and then building a house on it or building a pool in your back garden if you have the space. These kinds of developments make properties unique and bolster the selling price, meaning that you have a greater chance of making a higher profit.
What is Rental Yield?
A rental yield is the amount of rent you are expecting to accumulate from your property or properties within a standard year. There are many external things that can affect your rental yield, and this includes the area your property is in, property prices, interest rates, rents, and tenant demand.
Rental yield is a crucial figure to consider before you buy a property with the intention to rent. It is important to calculate the percentage of rental income you could receive beforehand in order to assess whether a property would be a good investment or not.
Typically speaking, a good rental yield in London is between 5-8% of the cost of the property. A solid rental yield should be high enough that your total rental income covers all the necessary costs of running your property or properties while making a profit.
For example, you need to know whether you can afford to cover the cost of your buy-to-let mortgage. Knowing your rental yield before you buy a property helps you to know whether the mortgage payments would be attainable to upkeep.
Elements like property management costs should also be kept in mind, as you don’t want to have to find an alternative or emergency funds to cover any costs you could incur from letting your property.
You want to make money as a landlord, not lose it!
So How Do You Calculate Rental Yield?
Calculating rental yield on a property that you own is very easy to do. There are two forms of rental yield: gross and net.
Gross Rental Yield
Calculating gross rental yield is easy. First, you need to find the total of a year’s rent on that particular property. Then, divide this number by the total property value. Finally, you need to multiply that figure by one hundred. This produces a percentage, and this is your gross rental yield.
Here’s an example is broken down for you:
- Original cost of bought property = £350,000
- Annual rent income = £14,400
- Profit = £50,000
- Divide annual rent income (£14,400) by original cost of property (£350,000)
- Answer = 0.41 multiplied by 100
- Answer = 4.1% gross rental yield.
There are also free rental yield calculators online if you need to double-check your calculations. Such as LandlordVision or Douglas Allen.
Net Rental Yield
Working out the net rental yield for your property is a more accurate and precise calculation to show the total profit you make on your property through lettings.
The net rental yield calculation includes your property’s running expenses (bills and/or mortgage payments) as well as covering wear and tear, general repairs, insurance and agent fees.
In order to calculate net rental yield, and work out how viable an investment decision is, simply subtract annual expenses from the annual rental income, and divide this result by the total cost of the property. Then, you need to multiply the result by one hundred to produce your net rental yield percentage.
How accurate are my calculations?
If you don’t already own the property, and you’re trying to calculate the rental yield for a potential property investment, you may find that these calculated figures aren’t super accurate. That’s because you don’t necessarily know the exact figures yet of your new rental.
For example, you won’t know for certain the upkeep expenses of the property or even how much you should charge your tenants for rent.
Therefore, it is important to keep in mind that anything you calculate for a potential rental property is estimated and subject to change. You should also be aware that your rental yield calculation is only as accurate as of the numbers you put into it.
The highest rental yield is not necessarily the most important factor in having a successful rental property. Yes, a high return on investment is great, but you also need to consider other factors to boost your investment returns.
Check out things like the area you may purchase in, the type of tenants you want to rent to, the length of the tenancies you may get. All of these can affect your overall RIO.
How to Increase Rental Yield?
There are a few ways in which you can increase your annual rental yield. These are actions that you can take if you are losing money on your property or properties. For example:
- Increase the rent.
This is not an endorsement of recklessly increasing the rent you charge to your tenants. However, check the general market rate for your specific area. If the rent level you have set is lower than this amount, you may be able to increase it. However, you will need to ensure that this is permitted within the Assured Shorthold Tenancy Agreement.
- Cut the rent rate.
This may seem contradictory to the previous point, but it may make sense for your situation. If the rent level you have set is above the general market rate, it will be harder to retain longer-term tenants. You need to ensure your rent is reasonable enough for the area and amenities you are offering. Lowering it may encourage tenants to rent from you and can help to keep your income consistent.
- Update your property.
You may be able to increase your rental yield by updating your property. This can be through updating appliances, paint work, or furniture. It can even be updated through making the property pet friendly. By adding or changing alluring qualities to your property, it may warrant a slight rent increase but is more so likely to keep tenants in the property for longer.
On a similar note, purchasing newer furniture and appliances for your property may make them more reliable and durable. Having things at the beginning of their life cycle is more likely to last longer, reducing your replacement or maintenance costs.
Should I Focus More on Capital Growth or Rental Yield?
Whatever RIO you choose to focus on is very dependent on how you want to make your money back. If you’re someone who is wanting to make more of a passive income, you should perhaps focus on rental yield – that’s if you find good property managers to do the work for you of course.
Although, if you aren’t looking to make your RIO straight away and are considering a more so longer-term strategy, then it may be worth you focusing on gaining through capital growth.
With capital growth, you are resting on the belief that the economy is improving, and house prices are rising. So, you might consider the past performance of an area and future forecasts more than the current tenant demand.
However, with rental yield, you are betting against an increase in housing prices and interest rates. Therefore, you want to be on the level with your tenants. You need to know what tenants want and are looking for, and more importantly, which locations deliver these.
But in reality, there is no real simple comparison of one RIO strategy being better than the other.
It could be worth considering both options before ruling one out over the other. Who’s not to say you can’t do both – rent out your property with the intention of gaining capital in the next few years.
Our thoughts
When considering entering the space of property investment, it is important to compare both capital growth and rental yield. You should carefully consider what your goals are. This is because which facet of income you want to focus on is dependent on what your goals are and where you are on your journey.
There is a risk with property investment in the same way that there is a risk with any investment. You have a better chance of succeeding in the market if you have all of the information, so make sure you keep doing your own extensive research!
While it is clearly important for landlords to make money, it is also important now more than ever in a post-pandemic world to charge fair and affordable rent for your property.
If you have to charge high and unaffordable costs for either strategy to make your investment worthwhile, it probably isn’t the best choice to invest in that particular property.
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The correct advice can be integral in making the right choices in property investment. Feel free to reach out to us here at Keey, where we have experts ready to answer all of your questions!