Capital Growth Vs Rental Return Investment Strategies

Property investment strategies generally take two forms: capital growth or rental return. So how do you choose the right one for your investment portfolio?

When you’re putting together a property investment strategy, you’ll generally need to make a choice between targeting capital growth or income. 

While both can be effective ways to build wealth, they work best in different circumstances, with different types of properties and with different financial goals in mind. Let’s look at what the strategies involve, which one you should choose and how negative and positive gearing play a role.

Capital Growth Strategies For Investment Properties And Negative Gearing

Focusing on capital growth is a long-term investment strategy where you look to invest in properties likely to increase in value over time. Often, you won’t release the full benefit of your investment until sale time when the property can be sold for a higher price and the added profit goes back into the investor’s pocket. Sydney investors have often had great success with this approach over the past few years, thanks to the sharp increases in price from 2012 onwards. 

Properties with strong capital growth are often found in highly sought-after areas, especially those with great access to amenities, commuting options and lifestyle benefits. Beach hotspots like Bondi and affluent suburbs like Woollahra fall in this category. Both have experienced an annual growth rate in houses of more than 10% over the past five years.  

But this high demand also means these properties are often more expensive to purchase and manage, and the rental income won’t always be enough to cover costs, especially if you need to take out a sizeable mortgage to buy your investment property. For instance, the average yield on Woollahra houses is just 2.2%, according to data from realestate.com.au 

You’d need to cover any gap between your outgoings and the rental income you’re paid. When this happens it’s known as negative gearing. 

Even though you’re effectively making a short-term loss, this is a popular investment strategy as Australian tax law currently allows investors to deduct any losses from their taxable income. However, this may change. There is an election due in 2019 and the ALP has proposed a reform that would limit this to brand-new dwellings only. 

Rental Return Or Income-Focused Investment Strategies And Positive Gearing 

An alternative property investment strategy is to focus on producing income from the get-go so that you have the ongoing cash flow to cover mortgage repayments, fees and other expenses. 

Targeting rental return requires a property to be positively geared, where the income from the property is higher than the expenses. This gives you extra money in your pocket each month, but you’ll need to pay tax on that income at your marginal rate.  

There are some other downsides to targeting rental income as a strategy. You’re more susceptible to short-term fluctuations in the rental market, such as seasonal variations in demand. This can have an immediate effect on your cash flow. 

That means if you’re looking to implement an income-focused strategy in Sydney’s Eastern suburbs you may consider looking at ever-popular areas like the beaches, as well as the student hubs and booming infrastructure locales like Kensington and Randwick (both 3.4% yield) or Centennial Park (4% yield).

There is also the chance that your property may not experience the same level of capital growth over time. However, this isn’t always true. 

Which Investment Strategy Should You Choose? 

There’s no one-size-fits-all solution for choosing between a rental return or capital growth strategy. It depends entirely on your circumstances and your investment goals. Do you need the money now to cover your costs? Rental return might be the right strategy for you. Looking for long-term opportunities to build wealth? Capital growth is likely the right choice, especially if you can easily afford your mortgage repayments and management fees. 

Whatever your situation, consult your financial advisor or contact our team of specialists and we will connect you with our strategic partners who can help you make the right decision for you.