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Jeremy Sheppard

10/01/2018
Blog post by Jeremy Sheppard

How Reliable is Rental Yield in Location Research?

Hi, I’m Jeremy Shepherd. Today I’m talking about yield. Yield is one of the indicators we use at Empower Wealth to help our clients find good investment locations.

 

The yield is defined as the percentage of rental income versus the value of the property. So, if you have a property worth $500,000 and you’re getting $500 a week — over the course of a year, this turns out to be about a 5% yield.

The yield is obviously of importance to investors from a cash flow perspective, but it can also be an early indicator of capital growth.

This is similar to how vacancy rates work. You see, it’s a lot easier to get a lease than it is to get a mortgage — and this makes tenants far more agile than investors or owner occupiers.

So, let’s say we have a suburb that becomes appealing for whatever reason — it could be new schools or infrastructure or jobs in the area — whatever it is, tenants are the first to capitalise on it. They’re the first to move in.ca

Now, what that does, is it places pressure on rental accommodation in the area, and rents go up. Of course, this is of interest to investors. They find increased rents appealing, and so they start to buy there.

Whatever it was that made the location attractive to tenants … it’s also what’s attractive to owner occupiers — they’re humans too, right?

So, the owner occupiers eventually get their act together. Now you’ve got investors and owner occupiers both buying in the location — and this pushes property prices up. So the yield, if it gets high, can be a good early indicator of potential capital growth in the future.

 

But you’ve got to watch out: a yield can get high because of falling prices — and you don’t want this to be the case. You definitely want a high yield … but a high yield brought about by rental growth.

There isn’t really a benchmark that we can talk about for the yield; but if you want one countrywide, it would be, say, 4.5%. In saying this, in some markets — like Sydney and Melbourne — this seems unrealistic. Whereas, in other markets — like in Hobart — this would be quite achievable.

So, what you probably want to do is look for markets where the yield has gradually been increasing over, say, the last year or two. This is a good early indication, when combined with vacancy rates and rental growth, of the potential for capital growth.

The yield is quite an anomalous statistic.

The reason why is because, what you’re doing to calculate the yield is, you’re comparing median rent with median value. Medians suffer from all sorts of anomalies from month to month — so you might get a change in the type and nature of properties that are actually selling.

For example: let’s say in month one you had a whole bunch of 1-bedroom units sell for $400,000. The second month you have a whole bunch of 2-bedroom units sell for $600,000. This hasn’t been a 50% growth in the value of units … it’s just the nature of properties that have been changing. The same can be said for calculating the median rent.

So, if you get one anomaly multiplied by another, you can get a very weird yield so you really need to check out the yield a little bit more closely by looking at the quality of finish, the location of each property, and make sure that the yield is indeed accurate.

It’s one of those statistics that bring a lot of investors undone.

It’s also a statistic you shouldn’t rely on entirely — as can be seen with the collapse in resource and mining towns over 2015-16,  where we saw a lot of problem investors buying and holding properties in these sort of high cash flow markets; in Perth and Queensland. So you’ve got to look at a whole host of indicators, not just yield — and don’t be sucked in by just this one indicator.

 

If you’re interested in learning more about the other indicators we use at Empower Wealth when we’re doing our research, check out our research page.

Thanks very much for watching, and you can leave your comments in the section below.

 

 

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