Podcast: Tradeoffs Between Capital Growth and Yield in Property Investment | Ep. 242

Posted by Ed McKnight on 12/05/20
Tradeoffs Between Capital Growth and Yield in Property Investment 001
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Show Notes

What's Covered in the Show?

In this episode, we discuss the tradeoff that is typically made between capital growth and cashflow (also known as yield) in property investment.

In particular, we deep dive into the reasons why yield properties tend to get lower capital growth and vice versa.

We also mention our upcoming property investment webinar, which is happening on Tuesday at 7pm. If you'd like to attend, you can register using the link 👈


Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show we're talking about the trade-offs you make within property investment and in particular being really clear about what you're looking for in property investment, because there are trade-offs.

And the reason I bring this up is I recently gave a webinar talking about how do you analyse data for the Auckland Property Investors Association, and I got an email afterwards from a really nice gentleman who was interested in the comments I made about Christchurch and how Christchurch's ,we believe Christchurch is at the bottom of its property cycle, about 15% undervalued and that we'd expect growth to return to Christchurch.

And so he sent me a lovely email, kind of mentioning that he wants to purchase, and this is his key buying criteria. And this is why I'm a bit puzzled and want to talk about this. It was all about really being really interested in the capital growth, but then said, look, I want to purchase something with a starting gross yield of six to six and a half percent, and then to renovate it to eight to 10% gross yield within 12 to 18 months, dah, dah, dah.

And the reason this stuck out was because on one side you really interested in capital gains and growth. And then on the other side, being really fixated or looking very closely at the yields. Now of course, I'm not discounting yield. I'm not saying that getting yield is unimportant, it's very important for you to be able to hold growth property. But I'm just saying that there is a trade-off often between getting really good capital growth and getting yield.

Now, this was actually one of the questions that came up and last night's webinar, at the time of recording where we talked about yield properties and people were asking, well, why is there this trade-off between yield and capital growth properties?

And I just wonder, Andrew, do you want to talk a bit about this?

Andrew Nicol: So, I'll just talk a little bit about what we covered in that webinar. So we, we actually showed the bell curve of where property's sit in terms of growth and yield. And, definitely you find that on one side of the spectrum you have high yielding properties, which will always sacrifice capital growth.

And then when you look at the other side, you get high growth properties that you sacrifice yield. And, actually in this webinar, we showed that both of those ends can be really great investment properties. You can find properties at the end of those bell curves that make really great rental properties. But in the middle, the 80 or 90% of properties right in the middle, they're kind of neither here nor there.

And, they're the confused ones, I think you called them Ed, and so that they're the ones that really make bad investments. And actually they're probably the ones that are bought by people who don't have a plan in place for what their buying criteria is, which is so, so important.

And Ed, you're the economist, you'd probably be able to give a better answer as to why there's always this disconnect between the two.

Ed McKnight: Well, I think that the real reason is that I want to start by talking about yield properties generally, because when we look at a lot of yield properties, there's either two situations. One. They're either theory niche properties, and what I mean by that is they are room by room rentals or they're something along the lines of a dual key apartment.

So quite niche investments that do produce higher yield because they are structured that way. You know, it's a multi-income property. Whereas in a dual key apartment, you can rent once one part of the apartment and the other side because they are structurally separate, or with a room by room rental it's the same thing. You've got multiple people in there paying you rent, and so you tend to get that higher yield off that property because you're able to lease it out as a, there's multiple income streams behind that.

And so there's that kind of situation where it's a very niche property or the other is where you create a yield property. And this is something that you'd typically see in a bit more of an old school property investment book, where in the past you'd buy a piece of land that had quite a big backyard and you might build a minor dwelling unit on that so that you get two income streams off that property.

But again, you're kind of then niching down that property a little bit. Of course, you get some capital gain cause you have put another dwelling unit on the back of your property. But then when somebody comes to buy it, there are two units on it. And that may not be what everybody is particularly looking for. And so you can kind of find yourself, niching yourself in to a particular asset type, if you understand what I mean. And so that's why we tend to see high yield properties, not always getting that same level of capital growth because there is a smaller market for what I would consider niche property types.

So like the room by room rental, the dual key apartments, specific apartment blocks for instance, because there are fewer people out there looking for that type of investment. And similarly, if you are investing in something like a room by room rental, then it is more than likely going to be owned by an investor as opposed to an owner occupier. And in that case, you may, when you come to resell it, you're only selling it to investors who are looking for sharp deals and are only going to be focusing on the numbers as opposed to being caught up in the emotion of the place. And so because of that, that's why you typically see yield properties being lower growth.

The other thing, and this is actually something that we talked about in Darcy's podcast just a couple of episodes ago, where we talked about the crowding out of yields. So everybody wants capital growth, and the main reason behind that is that it's that's the real place that you make money. And we've talked about that within property investment in the past. And so if you have a really high yielding capital growth property.

So it's maybe something that stand alone out in Rolleston or something along those lines, Andrew, then you would typically see more people buying those properties as opposed to yield properties, right? So because they know that it's going to get more capital growth, so you have increased demand, people start to go and buy those capital growth properties, but that pushes the yield down. If there's more demand for a particular asset, you're going to see that yield going down.

And so of course, you see lower yields coming out of a capital growth property if there's more demand for those kinds of both standard type of investments because it is more standard in New Zealand to invest in a house than something like a room by room rental. But also people looking for the capital growth.

And that's where you see the yields going down. Does that kind of make sense?

Andrew Nicol: Yeah, and I think this is one of the really interesting things that we are making sure that clients really understand what their buying criteria is and what they're actually looking for. And, in our webinar last night, which you can re-watch on our website. Opespartners.co.nz/previous-webinars, we're putting all of them on there now. We talk about the fact that everyone who's a true investor does want to get to a position where they're living off their properties and they're going to be living off a yield based portfolio.

But for most investors, they're not there yet. Because if you go out and try and buy a bunch of yield properties that you can live off the income, you need a whole lot of them. And for most people, unless you've got a whole lot of cash, or a whole lot of equity in other assets other than your home that's simply going to be unachievable.

And so you have to achieve the growth before you achieve the yield. And then you need to have a strategy of how do I hold onto those growth. So I'm actually following on from that webinar, one of my old clients rang me today and we were working through a reconfiguration of his plan. He's got one growth property already.

We've decided that because he's got really good income and he can afford some contributions again, he will look at another two growth properties, sorry. So he'll be growth, growth, growth, yield. So he will buy three growth properties before he sacrifices for the yield, but the yield will then help see those growth properties into retirement and beyond. So he'll get really good equity out of those. And then we'll start that transitioning process to the yield based portfolio because he will have the equity in assets other than this home to be able to afford to do that and get a really good return on investment.

Ed McKnight: And the key thing there again, is to be really cognisant of the fact that there are trade-offs within property investment. For those of you who've listened for a long time, you remember when we talked about this kind of triangle in where you can choose two of these three things, which is yield, capital growth and no cash deposit.

So the idea being that you can buy a capital growth property and have it yielding positive cash flow every week, you just usually have to put in a cash deposit in order to be able to do that because the largest cost within an investment property is your financing costs, which we showed on the webinar last night. If you want your capital growth property to yield cash flow each week, it's very simple.

You put a cash deposit and that brings down your finance cost and then it's yielding positive cash flow. But if you can't do that, then you've got the decision to make. Do you want to have no deposit and get the yield or do you want to have no deposit and get the capital growth and potentially put in a little bit of cash each week?

Now I know that with interest rates as low as they are at the moment, Andrew, some of the Christchurch and Rolleston properties that we're currently recommending, I think that sounded about right. $2 or $3 contribution per week once you factor in all the costs.

Andrew Nicol: And in fact, some properties that we're dealing with in Christchurch at the moment, are cashflow positive from day one and they're growth properties. So it's an awesome time to buy for those kinds of things.

And even something like Auckland, which is the rock star when it comes to growth, the cost per week at a hundred percent borrowing as nominal, like, less than a hundred dollars in some cases, like $20 was one that I did for a client today.

Ed McKnight: Fantastic. And I know we've kind of jumped around a bit here talking about lots of different things that have jumped up that are very interesting, but the key thing that we do want you to focus on is that there are trade-offs in property investment. It's very difficult to get a really good capital growth property, and have it very high yielding unless you're going to go and do a whole heap of work on it yourself and kind of turn it into a property like that.

And that was something else that we noticed last night on the webinar where people were asking, well, how do I get both? Well, you can't necessarily, you can't buy something that has both of these. There are trade-offs. And that's where you structure your portfolio in such a way that you get the best of both worlds.

But look Andrew, let's, wrap it up there, but please don't forget to rate review, and subscribe to the podcast. It really does help us get the message out to more people and hey, if you want to come along to our next webinar where Andrew and I will be presenting together about the right areas to look for, actually how to select the right area to invest in then go along to our website Opespartners.co.nz, you can sign up there. I'm also going to drop a link in the show notes, so tap or swipe over that cover art it'll take you right there.

Thanks for listening to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and we're going to be back again tomorrow with even more daily strategies, tactics, and insights to help you get the most out of the New Zealand property market.

Until next time.