Rental Yield and Capital Growth

Understanding the economic factors that drive changes in property price are
critical to a successful long term property investment strategy.

Most investors appreciate the simple supply-demand equation. If supply drops
and demand remains constant or increases then in a free market the price increases.
It’s inevitable. Over a short time there can be fluctuations but long
term the market will win out and prices will rise.

There is another equation that most investors also think is important. When
rental yields are high, above general market rates, investors want to buy.
Supply is relatively limited and so prices will increase. And then rental yields
will drop, to a point where a property investor is less interested because
other secure investments become attractive.

So when interest rates are rising, as we are experiencing through 2006, yields
will fall, property becomes (in theory) less attractive and prices stop rising.
In fact in a market with unlimited supply property prices could even drop.

That’s the theory. But in reality you can’t use rental yields to
second guess what’s going to happen in the housing market. Why not? Because…

House Prices Are Not Driven By Property Investors

All the logic above would be true if property prices were driven by property
investors. But this is not what happens. In the residential market property
prices are driven by owner occupiers – they currently account for around
92% of all residential property purchases.

And owner occupiers are not interested in the theoretical yield from renting
their property – they intend to live there. What does it matter what
their property would rent for?

The drivers of capital growth in the residential housing market are different.
Firstly, on the supply side we have seriously restricted availability (in the
UK) of new build property. The UK is running out of buildable land unless we
encroach on the countryside. That’s unlikely to happen anytime soon!
Then take the demand side – we are facing a future with greater requirement
for housing units; increased breakup of families, inward immigration, regional
population movement (eg 1m extra people in the South East in the next 20 years)
and more.

With scarcity of supply and increasing demand there is only one long term trend
for property prices – upwards. And this is regardless of the rental yield!
The only constraint on property prices moving ever upwards is affordability.
And perhaps surprisingly, even with base rate today at 5%, interest rates are
still low by historic standards.

Owner occupiers will stretch themselves to the limit to purchase a property.
No surprise really given the wealth that is created by rising property prices.
For many owner occupiers the equity in their house or apartment represents
the only equity they possess!

Given this scenario, investors who buy in the right area have a rosy future
for capital growth. In fact it will be pretty difficult to go wrong if you
take a 10-20 year view.

Investors in UK residential property can be confident  that short term
fluctuations in interest rates will not impact the significant growth that
they will benefit from in the years ahead.

High Rental Yield Can Lead To Capital Growth

The challenge for investors looking for cash flow is to find property that
delivers above average rental returns. That’s pretty difficult, at least
in the UK right now. A true cash flow property needs to deliver at least 2%
more than the current mortgage rate – say a minimum of 7.5% at the current
time. And gross rents of 10% plus would be better.

That’s assuming that you want to leverage your cash by mortgaging the
property to the hilt. Investors who are looking for cash flow and have ready
availability of capital can always create positive cash flow just by putting
more money into the deal. But for many people this isn’t an option.

There are few opportunities to achieve positive cashflow with UK property right
now, but there are opportunities overseas, so don’t be disheartened.

What happens when investors discover a property investment opportunity that
delivers high yields? They pile in and therefore increase demand. Supply doesn’t
change so prices will increase.

Bottom line – High Yields can be nirvana for a property investor. Excellent
return now followed by strong growth as other investors drive prices higher
in that local area. The key is to find an area before the mass of investors
and build a good portfolio. Then you end up with high yields today, and high
growth later!

At Axis we’ve been fortunate to identify an area where current (2006)
gross yields are in the 20% to 40% pa range and sometimes even higher. This
is exceptional and will only last until the demand from investors pushes up
prices.

Visit www.axispropertyinvestment.com,
register (it’s free) and download the USA Market Report. You’ll
find it makes fascinating reading.

What’s Better For Investors In Property – Capital Growth Or Cash
Flow?

There’s no easy or right answer. It depends on your individual circumstances.
If you need an income right now, then cash flow properties are essential. But
tricky to find, at least in the UK. And you may find that your cash flow property
isn’t in an area of good capital growth because there isn’t the
demand from owner occupiers!

On the other hand, if you have a medium to long term view capital growth properties
are always going to be a winner. And if you do have strong capital growth there
are many ways to turn that back into cash flow…

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