When considering an investment in real estate, it is important to decide the type of income you wish to earn from the property. Capital gain and rental yields are two ways to earn money as a property investor, so it is important to understand the difference between the before buying an asset. Rental yields are often considered a key signifier of a property’s potential. Capital gains are also important, but the significance of each depends to some extent on an investor’s personal or financial circumstances.
Capital gain is the profit resulting from the sale of a capital asset as a percentage of the original purchase price. For example, if you paid Dh200,000 for an apartment and you sell it five years later for Dh225,000, you take the amount by which the price of the apartment has increased and divide it by the original purchase price to get 0.125, or 12.5 per cent.
Predicting a property’s future price is, of course, speculation. Furthermore, the asset price can go down, resulting in negative capital gains or capital loss.
Rental yield, particularly net rental yield, is a good indicator of how much cash flow investors can expect on a monthly basis from their tenants. High rental yields suggest that an investor will be able to cover the costs of mortgage or management fees from the rent, and potentially have some left over. Higher yields can even make it easier to get loan or mortgage approval.
A growing population of an area is something that investors look for. Growth factors such as redevelopment and investment, enhanced transport links, employment opportunities or improved amenities appeal to both renters and owner-occupiers.
Which is better?
When it comes to investing in property, it’s important to get the balance between rental yields and capital gains right according to the investor’s circumstances. Investors need to be able to fund the property investment and if they need the rental income to cover mortgage repayments, then rental yields may need to be at a certain level. However, chasing returns at the expense of solid, sustainable, long-term growth is also not wise. It’s always prudent to bear the bigger picture in mind.
Higher rental yields can mean a property pays for itself and in some instances cash reserves are generated, but on selling, capital gain is less. Where cash flow is good, consider ways you could add value to the property yourself, through renovations and other improvements.
In a best-case scenario, high rental yields and strong capital growth are desirable, but these do not always go hand in hand, so consider your financial circumstances. Overall, it is important that you find the right balance for you.
Richard Bradstock is director and head of Middle East at IP Global. The views expressed here are his own.