By DANIEL CHERUIYOT
One of the most debated subjects in real estate investing is whether the strategy for creating wealth should put more emphasis on capital growth, or rental yield.
Capital growth is the increase in property value over time, while yield is a measure in percentage of the return from rent. Yield is calculated by dividing the annual rental income by the purchase price or property value.
Those in favour of capital growth say it is the most direct and effortless way to build wealth since their net worth grows with rising property values. But investors who prefer rental yield say their properties give them positive cash flow from day one.
If the two groups were to be examined, the stand of each would probably be related to their different circumstances and the markets upon which they operate.
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When a person is employed, buying a rental property, using mortgage, would be the ideal means. Similarly, a young businessperson with cash to invest may be better off buying a plot and waiting for it to appreciate since financial commitments are still few.
An investor in a vibrant property market with persistently high property prices and depressed yields would most likely consider capital growth. Investors put resources where taxation gives them the highest benefits and avoid highly taxed asset classes.
In Kenya, lower yield and tax on rent have reduced investor interest on rental properties. As a result, more focus is now on land because making absolute profit on land is assured and easy since there is no capital gain tax upon sale and no effort is expended in adding value.
Here are two hypothetical investment scenarios showing differences in return between a rental property and vacant land.
In April 2008 Maria Ropia, a banker bought an apartment in Nairobi for Sh8 million through mortgage. She spent an additional Sh110,000 on improving security and redecoration. Her mortgage repayment on the Sh7 million she borrowed for 15 years at 15 per cent interest was Sh98,000 per month. The apartment was rented out at Sh50,000 per month with provision for ten per cent escalation annually. She topped up the shortfall on loan repayment from salary. In May 2013, she sold the property to a colleague at Sh15 million and made Sh7 million on capital gain. By then, the rent had gone up to Sh73,200 per month. The buyer took a Sh13 million loan at 15 per cent interest repayable over 15 years. His repayment is Sh182,000 per month.
Around the same time, Teeta Wangombe, bought ten acres in Embakasi adjacent to the then proposed Northern Bypass for Sh8 million using his savings, fenced and left it. Recently, he sold the parcel for Sh40 million, making a profit of Sh32 million.
From the above analysis, Maria earned less despite the additional expense on security and redecoration. Wangombe, on the other hand, did little and ended up with more profit. Maria’s colleague is likely to end up in a worse position because rental yields have generally gone down. For this apartment, it dropped from 7.5 per cent in 2008 to 5.8 per cent in 2013.
It is important to note that established investors use a balanced strategy. They buy properties with strong capital growth to generate equity and those with good yield to provide the cash flow to cover cost.
The strong demand for land in urban areas of Kenya and slower economic growth is causing prices to rise faster than incomes.
And as the escalating prices are factored into new houses, peoples’ ability to buy is steadily being eroded. Consequently, affordable housing is increasingly becoming a mirage for many, while those fortunate to have invested on land early are growing wealthier.
— The writer is the head of property valuation, Regent Management Ltd