What it is
A model that compares the returns of a property purchased for yield vs. a property purchased for growth. Taking in a few assumptions around purchase price and yield, it projects the cash flow and capital gains from the property over 5-30 year timeframes.
Why I created it
There is a religious debate in the real estate world around whether yield or growth are better investment strategies. Like most types of advice, it depends. Both yield and growth can provide attractive returns over time as long as you don’t overpay given the assumptions you’re making going in. I wanted a way to view this tradeoff so I could understand it more intuitively, and play with some of the assumptions. A few of the key takeaways are that:
- Combine cap rate & growth: Generally speaking you want the combined cap rate plus rental growth rate to be a comparable value in order to achieve comparable returns over time – i.e. a 7% cap rate with 3% rental growth offers comparable returns to a 3% cap rate with a 7% rental growth rate
- Stability vs. change: When you buy for yield, you’re basically betting that the area maintains its value – you don’t need much growth to get your returns (just keep up with inflation). Basically, you’re betting stability. When you buy for growth, you’re betting that prices will appreciate in a material way. If you don’t get that growth, then your returns will suck. You’re betting on change and growth.
- Risk & timeframes: Lastly, it’s worth noting that investing for yield is generally a more conservative approach. Seemingly lower risk, but also more muted upside. In addition, the time frames for ‘yield’ investing require you being in it for the long term. When investing for growth, you could get a few years of tremendous growth, which will give you material upside – sometimes returning you many multiples of your original investment in a short time frame.
So depending on your investment goals and risk profile, you can decide where you want to be on that spectrum.
How you can use it
Check it out at this link, make a copy for yourself and feel free to edit the inputs as you see fit. Play around with the assumptions to understand how it affects returns. Figure out what type of properties you’re targeting and see what assumptions you need to believe to get the returns you’re expecting.