Every investor’s journey starts somewhere. Maybe you have a small deposit to kick things off. Maybe you’re in the market looking for your first investment property. Whatever your situation, chances are you’ll come across some vocabulary you don’t understand, making the whole thing seem a little daunting.
We’re here to help. Here are some simple explanations on the key terms every beginner investor will encounter:
Rental yield (Gross and net rental yield)
Rental yield measures the profit a property generates each year as a percentage of its value.
It’s calculated with a simple formula.
Gross rental yield: Annual rent/property value x 100
Net rental yield: (Annual rent – all expenses [mortgage, insurance, letting fees, etc.])/property value x 100
As you can see, the two are very similar. But net rental yield is generally a more accurate figure because it takes into account expenses and outgoings
Understanding how rental yield is calculated can help you determine your potential profits & losses and whether or not it’s worth investing in a given property.
A rental yield between 8-10% is considered high and implies the property is undervalued.
A rental yield between 2-4 % is considered low and implies the property is overvalued.
As an investor, a higher rental yield is generally favourable because it generates stable rental income and a steady cash flow. You can look at median rental yields across your suburb to get an idea of what to expect.
But keep in mind that experts advise against making rental yield the sole consideration in a property investment. The ideal solution is to marry rental yield with capital growth and maintain balance in your portfolio over the long term. We will get to what capital gain is next.
Capital growth/Capital gain
Capital growth/gain is typically the main attribute investors seek.
Capital growth is the amount your property has risen in value over time you have held it. And capital gain is the profit you can earn upon the resale of the property.
It’s worth remembering that in Australia, property investors must pay tax on their capital gains. But since Australian property has such a solid track record of skyrocketing in value, it’s still the go-to choice for investors.
Positive & Negative Gearing
Put simply, positive gearing is when the property generates more in rental income than it costs in expenses (such as fees and loan repayments).
Negative gearing is the opposite – the property makes an annual loss because the income from rent is lower than the cost of expenses.
The benefits of positive gearing are self-explanatory, but why would anyone want to negatively gear their investment property?
If the property has future growth potential, it’s a common investment strategy to use the tax deductions and benefits that come with negative gearing to make profit in the long term via capital gains.
One way to determine whether the area you bought into has growth potential is to check the vacancy rates. The vacancy rate is a simple percentage figure that tells you how many rental homes in the area are vacant. Increasing vacancy rates may be a red flag telling you to sell before your property declines any further. But the opposite indicates a popular suburb with high growth potential.
Equity is the difference between what your home is worth and how much you owe on it.
Many homeowners looking to generate an additional revenue stream beyond the 9-5 daily grind are potentially missing out on an easy entry to property investment through using equity.
By using your home equity as security with the bank, you can borrow against it to purchase an investment property. This avoids the need to save for a deposit – allowing you to own an investment sooner.
As the value of your investment property rises over time, you can use this equity to refinance and purchase another investment. This property will in turn rise again, allowing the investment pattern to continue.
“Using equity to get a foothold in the market is a great way to start building an investment portfolio,” shares Anthony Webb, PhilipWebb CEO. “By using equity, you are able to keep cash in your pocket – minimising the impact on both your cashflow and lifestyle. It also fast-tracks investing – it takes a long time to save money!”