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Capital Growth Strategy Concerns Rental Income Tradeoff
Property investors who go for a capital growth strategy are focused on exceptional appreciation on property values that more than compensates for potential negative rental cash flow. If we take for example that the expected return for an investors is 10% per year, the target appreciation might be 8% if rental yield is only 2%.
Capital growth on properties are driven by demand and supply. So to go on the road of a capital growth strategy, an investors has to identify a home whereby demand will be far greater than supply. Unlike rental income that can be predicted on a more current level, the demand for a particular property cannot be predicted to a degree of certainty. This also applies to a place like Singapore. The is absolutely no way anyone can predict the future.
Property buyers who applies this strategy are usually open to incurring negative cash flow on rental. This basically means that the income generated from rental are not enough to cover the expenses of maintaining the property. Thus, making a loss in rental. To combat this issue, the best way forward is to have a good grasp of market cycles to find a good time to enter the market. Although this loss can have tax benefits depending on where your investments are, negative gearing is a highly risky business to be in. Investments should be focused on profits instead of tax planning.
If you cannot comprehend the prospect of rental loss for the first 5 years, you are probably not ready to invest with this strategy. Capital growth occurs over the medium to long term. Exponential growth on Singapore properties in recent years are not normal. It is an absolute joke to fully expect immediate positive cash flow when you gear up to 80% loan to value for a property.
Properties that suit this form of investment tactics are usually those that are situated in growing cities and capitals where property prices are climbing almost all the time. Macro and micro economic setbacks can affect their prices, but properties in these areas always bounce back stronger when economies recover. Major cities are often built up to the brim with real estate. Therefore land become scarce in these areas. On top of that, employees often prefer to live near their workplaces in the cities. Foreign talent with juicy housing benefits can afford upmarket apartments within the city without forking out any cash from their own pockets.
Advanced capital growth strategy
A concept of leveraging has been gaining mass market acceptance even though it has been around for as long as investors can remember. It is the concept of cashing out home equity. Even the average households are now leveraging their finances by taking up home equity loans in their properties to make more alternative investments.
In layman terms, a home equity loan is simply a loan against your property. You can then use the extra funds to put in other investments or even buy more properties. It is generally understood that properties with the highest appreciation potential will have the lowest rental yields while properties with great rental yield will have a lower appreciation upside. An extreme example is to look at shoebox apartments. They have the highest rental yield but a subdued value appreciation. In view of these upsides and downsides, a capital growth strategy best suits investors with cash to burn and a longer investment time-frame for potential value to realize.
The recent rush to buy shoebox apartments in Singapore are highly driven by buyers with a capital growth strategy. If a buyer of a shoebox unit in Seng Kang is primarily focused on rental income instead of capital growth, he is either an investment maverick that sees things that others are unable to see or simply has no idea what he is doing. As there are thousands upon thousands of rental alternatives in heartland areas, great rental income from shoebox apartments in heartland areas are miraculous at best. Capital growth and rental income is a tradeoff that is tough to balance.
Pointers to success with this strategy
- Be prepared to absorb negative rental cash flow for as long as 10 to 15 years. Not that this will definitely happen. But it serves as a basis to plan your finances.
- Capital growth is focused on exponential net worth increment over the long term. Investors with a short term investment horizon should stay away.
- The finances needed to acquire a property becomes immaterial if you have a long term strategy.
- Speed of acquisition has a bearing on returns.
- 1 property is not enough to fund the retirement of your spouse and you.
- Properties with a higher growth rate than rental yield tend to appreciate in value more robustly in time.
- Leveraging on equity can allow you to build your net worth much faster. But be mindful of the risks.
- There are tax benefits on negative rental cash flow.
- If you own a few capital growth investments, selling one of them can usually cover all your accumulated expenses.
- Capital growth has to be benchmarked to inflation and exceed inflation by 5% to 10% for the investment to make sense..