The subject of ROI (return on investment) can be quite subjective. There are many angles from which to view an investment when you take into account risks versus rewards. At the end of the day, all we really want to know is, 'did we make any money?' and if so, ‘how much?’ on that particular investment.
When it comes to property, there are so many factors to take into consideration that we must take everything into account before we begin. The good news is that when it comes to buy-to-let, you can account for these cost implications from the off in the vast majority of cases. You can also have a good handle on the potential end values in terms of rent and what the property is worth before you put down a penny to buy it...as long as you know what to account for! As far as I know, the property business is the only business in the world where you can pretty accurately work out what your ROI is going to be before you ever part with any hard earned cash.
When working out your numbers, the question remains, ‘should I go for the highest yield or the biggest capital gain?’ The answer will be obvious when you question your end motives for buying in the first place. Your answer will determine where would be best to look for the particular objective you are looking to achieve. If you see your investment as an addition to your pension and are not too bothered about achieving a monthly income, then you can afford to look at higher value areas with more demand and potential for capital growth. Remember that if you leverage too highly, you run the risk of being caught in any hike in interest rates. If you do decide to invest for increased capital growth, make sure you have your own ‘buffer’ fund for any unforeseen bills that may crop up. Whilst capital gain is very attractive, you are really at the mercy of the market and can only work with historical data to determine any potential future growth.
When concentrating purely on cash flow, looking for the highest yield will be the name of the game. If you go down the cash flow route, ensure that you research the area closely. As with all high return strategies, there is often a good reason as they come with a higher risk. In this case, the type of tenant you may attract and the area as a whole. The main advantage with this approach is that you can accurately work out what your income will be each month, ahead of buying the property. Your return will be set from day one, notwithstanding any unforeseen circumstances that may crop up, of course.
In my opinion neither of these strategies come without their risks, so consider carefully before deciding which way to go. I believe the ideal situation would be to achieve the ‘sweet spot’ between yield and growth where you benefit from the best of both worlds. Next month we will explore how to achieve this in practice, making your portfolio stable, sustainable and highly profitable.
Enjoy the sunshine 'til then!
Hazel de Kloe | Why Property Works