Rental Yields of 1.3% by year 2029

[rich ando]

Help

I am looking to buy a property to live in but purchase in trust so when we move interstate we'll keep as IP.

Doing the analysis in PIA software I used the follwoing assumptions
- Purchase Price 950k
- Rent 600pwk (3.28% seems right for property of this value)
- capital growth 7%
- infaltion 3%

I believe these are relaistic and certainly reflect long term averages.

If you look at the position in 25yrs the rental yeild is 1.3%.

This worries me and although it reflects current trends (ie ever decreasing yeilds) at some stage it wont be worth investing with debt.

Does anyone think my assumptions are flawed....something does not fit?

Rent cant grow much more than inflation as it would be driven by wages?

There is a flaw in the logic somewhere..

Input welcome?

Richard

[jrc]

While your assumptions may be reasonable, if there is a flaw it would seem to be assuming that the rental income acceptable to an investor is divorced from the capital value. If the rent isn't going to grow similarly to the growth rate of the property, the law of supply and demand will apply with consequences ranging from:
a. an unwillingness of investors to invest in the market, thus resulting in an increase of rent as there will be more demand and a number of tenants will be willing to pay more
b. people deciding they can invest elsewhere for better returns than in a PPOR and wanting to rent, more renters will again drive rents up
c. if you are correct in your assumption rent will not increase by more than inflation, sellers may have to reduce prices
d. two or all of the above

jrc

[rich ando]

jrc

i agree which suggests that capital growth cannot be sustained at historic levels unless:
1) rent rises in line with CG...unlikely
2) market is driven by owner occupiers...

richard

[suggo]

Capital growth can be sustained at historical levels, but that's not to say that they will be that every year. Surely you can't expect the market to continue at 7% after the past few years of 20% etc. Historical levels are long term averages. Also to assume that inflation will continue to be 4% below capital growth is unrealisitic. There have been times in the past and will be times in the future where real values of houses will decline ie inflation running above CG. This is why IMHO the market forms a step shape graph in relation prices over time.

[AnthonyH]

I think there is a flaw in your calculations in that you are assuming rental increases follow CPI when in fact it is more closely aligned to the capital appreciation of the property.

As a real life example, my first investment property was purchased in 1995 for $156,000 and was rented out at $175pw. That same property today is worth $370k and is rented out for $350 per week.

If inflation alone increased rental yields then I would only be getting around $220.

[MJK]

Who is to say that inflation will stay at 3%. It could be 7% in the future ?

MJK

[Aceyducey]

Inflation could move enormously :)

From negative to hundreds of percent....

A fair guide may be to use the long-term Australian average (though this is past data & merely reflects past experience, not predicts the future). After all, the intention is to continue doing this for 20 years plus - correct?

From Sep 1970 - Dec 2003, inflation has averaged 6.6% and the median inflation rate was 6.7%.

I calculated this from the RBA historic data table & it doesn't take into account how the measurement of inflation has changed over that period (reflecting political goals & changes in economic thinking).

Note that over the past 33 years, inflation has gone as high as 17.6% and as low as -0.7% per annum as measured quarterly.

REF: http://www.rba.gov.au/Statistics/measures_of_cpi.html (Click the historic data button to download the spreadsheet).

Cheers,

Aceyducey

[rich ando]

Anthony

If your situation were normal it would all make sence but I dont believe thet are.

My personal experience is on IP purchased 1993 at 7.7% yield....on todays value and rent it would yield 3.6%. This is reflective of the published average yields.

Have you added value to your property?

I can't see how rents grow above inflation - ability to pay rent is driven by wages. Inflation is essentially driven by wages growth.

Richard

[AnthonyH]

Rich Ando,

My situation is normal as far as IP's in capital growth areas. 6 of my properties are in Melbourne around the likes of Templestowe and Kew, and I could site similar rental growth for them all.

If your IP was in a regional area, then I may agree with you that rental increases are more likely to follow CPI.

Have you read Jan Somers book? I remember BIS Shrapnel statistic in there citing the average growth rate of Melbourne property to be 11.2%pa and the average rental growth at 9.6%. This is from memory but will be near enough to the stat in the book.

When you think about it, how can rental increases not follow capital growth? Your own calculations didn't seem right which is why you asked the question from this forum. In other words, who would buy a property in 25 years if your assumption was correct and you could only get a 1.3% yield.

Incidentally, rentals in Melbourne are on their way up now that the market has softened and less people are buying IP's. Only this week did I put the rent up on a 2 bed apartment in Kew by $25 to $350.

[landlubber]

Rich Ando,
These things do even out over time. We've been through a period of great capital gains, plus lots of new investors have entered the market , this has kept supply up and hence rents have not risen. As a result at the moment yields are low ..but now less investors are entering the market. With interest rates up a bit and low yields we should expect fewer investors. Fewer investors reduces supply and rents start to increase. Many of our Melbourne IPs have not had a serious rent increase for quite a while ,,but we're starting to get them now in suburban Melbourne. In the near furure CG will be less but rents will rise. Also , with current high values and "higher" interest rates affordability is low and that stops the first home buyer ..who becomes a renter...increasing demand.
It all evens out . But rents will rise ..values won't fall.

LL

[rich ando]

Anthony

My IP's are in cottesloe (WA) and have averaged CG of 13.5% over 10 years. No wonder yields have droped.

My point was that nobody would buy a house on a 1.3% yield..meaning capital gains have to be flat for a long time for the rent yield to catch up.

Yes I have read the books..but could not find the answers there...

Your examples prove rent grows much higher than cpi...will be interesting to see what happens to rents in Cottesloe..

thanks for your input..

R

Rich Ando,

My situation is normal as far as IP's in capital growth areas. 6 of my properties are in Melbourne around the likes of Templestowe and Kew, and I could site similar rental growth for them all.

If your IP was in a regional area, then I may agree with you that rental increases are more likely to follow CPI.

Have you read Jan Somers book? I remember BIS Shrapnel statistic in there citing the average growth rate of Melbourne property to be 11.2%pa and the average rental growth at 9.6%. This is from memory but will be near enough to the stat in the book.

When you think about it, how can rental increases not follow capital growth? Your own calculations didn't seem right which is why you asked the question from this forum. In other words, who would buy a property in 25 years if your assumption was correct and you could only get a 1.3% yield.

Incidentally, rentals in Melbourne are on their way up now that the market has softened and less people are buying IP's. Only this week did I put the rent up on a 2 bed apartment in Kew by $25 to $350.

[Sunstone]

Dear guys,

Forgive the doublehandling, but something by Michael Croft directly related to this thread.

After say 30-50 years the price of the property (land) grows to a point that it has outstripped wages and serviceability so we turn it into a duplex. 30 to 50 years later we turn the duplex into a block of flats and after another 30-50 years a high rise block of flats. Heritage orders and other market distortions notwithstanding.

http://www.somersoft.com/forums/sho...94&postcount=57

That is what you are looking for Richard. ;)

Cheers,

Sunstone.

[jahn]

Hi Sunstone
Nice one
Simple and to the point
BTW does that mean we have to live another 90 to 150 years to own a high rise block of flats :( :confused: :D
Ok, I'll wait :rolleyes:
jahn

[Sunstone]

Dear Jahn,


Simple and to the point. BTW does that mean we have to live another 90 to 150 years to own a high rise block of flats

Certainly some waiting could be involved. ;)

However I believe if due diligence is done it is possible to identify the places where change is already taking place and so shorten the waiting time between one of the cycles. (Doing your own due diligence may enable you to identify an area just before it should be moved into the high rise category.)

Some abstract thoughts on areas of identification:

-Existing zoning. Medium and higher density zoning levels show us that the area is already in transition and council has already identified a better use for the property/land in question. (Especially where the current use does not match it's designated zoning. IE current use is inferior to zoning.)
-What is happening around the property/land? (It is sometimes easier to work with change than to kick start it. But beware of oversupply issues. That said JoannaK likes to be a trailblazer. ;) )
-Is it 500m to a train station or a shopping centre? (Council may be more receptive/flexible to change as you can more easily demonstrate a compelling reason for change.)
-Do you own multiple properties in the same area/street? (This allows you to have inside information on what changes are going to take place, and allow your properties to benefit through your direct development/upgrade activities. IE Playing monopoly in real life.)

Some abstract thoughts............

Cheers,

Sunstone.

[Kennethkohsg]

Help

I am looking to buy a property to live in but purchase in trust so when we move interstate we'll keep as IP.

Doing the analysis in PIA software I used the follwoing assumptions
- Purchase Price 950k
- Rent 600pwk (3.28% seems right for property of this value)
- capital growth 7%
- infaltion 3%

I believe these are relaistic and certainly reflect long term averages.

If you look at the position in 25yrs the rental yeild is 1.3%.

This worries me and although it reflects current trends (ie ever decreasing yeilds) at some stage it wont be worth investing with debt.

Does anyone think my assumptions are flawed....something does not fit?

Rent cant grow much more than inflation as it would be driven by wages?

There is a flaw in the logic somewhere..

Input welcome?

Richard

*****************************************
Dear Richard,

1.From what you have presented, I infer a few underlying assumptions being made for theoretical discussion:

a. Housing demand is more or less "inelastic" to result in the long term capital growth "naturally", assuming housing supply is constant factor.

b. Demand for rental properties is more "elastic" and rental yield more variable depending on prevailing supply of rental properties available as rental yield fails to catch up naturally with capital growth.

c. That rental yield fails to catch up with the house' long term capital growth. Is this true? Why?

2. Since you have assumed that this cannot be the case ( and thus there must be errors somewhere), your assumption is that the house's rental yield will and must naturally catch up with its long term capital growth somehow. Is this neccessary true? Why?

3. To assume that the long term rental yield should catch up with the house's capital growth is to assume that both the demand for houses and rental properties are "inelastic" or "elastic to the same extent" i.e when/assuming that the long term supply of new houses and rental properties are constant.

4. Have you checked with software creator, the underlying assumptions used in programming the PIA software. What is the actual relationship between the "inflation" parameter and the "rental yield" parameter used to programme the PIA software computations and projected rental and house values. I think that you will probably find some of the answers from there.

5. However, I think that the housing demand and demand for rental properties are 2 different things and that their respective demand and supply conditions varies accordingly at each stage of the property cycle as can be seen from the actual market situation at different stage of the property cycle.

6. At this point in time, I am not sure myself whether the long term rental yield will always catch up with the long term capital growth values of a house in the Australian residential property market. Or must it neccessarily be so for this market? What do the other members and gurus say then?

7. Thank you

regards,
Kenneth KOH

[Mark Leo]

Anthony

If your situation were normal it would all make sence but I dont believe thet are.

My personal experience is on IP purchased 1993 at 7.7% yield....on todays value and rent it would yield 3.6%. This is reflective of the published average yields.

Have you added value to your property?

I can't see how rents grow above inflation - ability to pay rent is driven by wages. Inflation is essentially driven by wages growth.

Richard

The rate of inflation is used as a baseline for negotiations on wage cases in the Australian labour market. If an industry's employers can demonstrate real productivity improvements their wages will generally increase by inflation + x. The reality is that x is either zero (no productivity increase) or a positive number. Therefore wages increase by at least the rate of inflation over time.

Rents are proportional to wage levels in the long run. Therefore rents will grow by at least the rate of inflation over time.

[AnthonyH]

I totally disagree. Not in high growth areas like Melbourne and Sydney anyway. The rate of growth on rent is driven primarily by capital appreciation of the underlying asset and not by CPI.

The very reason that people invest in property (other than CG) is because it does outperform inflation. If the underlying yield was to follow CPI then we would see yields diminish to 0% over time.

Yes we have been through a period of high capital growth and rents have not risen at the same rate. This is normal. You can't expect rents to rise by 20% in one year just because the house has. However you will find your rents will catch up over time, and I am seeing that for myself now.

[Aceyducey]

Always remember that CPI is a calculation based on a basket of different prices. It includes both the prices of consumer durables (such as cars) and consumables (such as food).

The basket is regularly tweaked to fit political and economic objectives & to make sense - ie, it's a kludge questimate of inflation rather than a true measure.

For an easy example, look at CPI increases over time & food prices...often food prices grow faster than CPI as any shopper would know!

So expecting property prices to 'obey' and 'match' a kludgy human-created guide to across-the-board living costs variation is not highly realistic.


Personally I've found the number of property gurus a consistently better indicator of property price performance than CPI.

Though there is a three year lag in guru numbers...I guess that's the time it takes to make a property guru ;)

Cheers,

Aceyducey

[House_Keeper]

My few cents worth...

Let's assume that inflation is under control and stays around 3% on average.

Rents are driven by people's ability to pay, which is determined mostly by wages. So if we expect inflation to be 3%, we can conservatively assume wages growth to be running at 4%. This means that rents should grow by 4%.

For investors, over the long term, it is unlikely that the yield will change, unless underlying interest rates changes. We have had huge growth in the last ten years when interest rates where mostly falling. However, do we expect interest rates to keep falling over the next 10 years?

In theory, based on affordability, capital growth for owner-occupiers is likely to grow based on wages growth, say at 4% per year. In the last 10 years however, we have had an increase of DINKs (a couple with no children) who would have had a higher borrowing capacity that the traditional family. I believe this has contributed to owner-occupiers ability to pay more for a house. However, my guess is that there is no longer an increase of DINKs. The other factor that would increase borrowing capacity would be the fact the money is passed down from one generation to the next in order to buy a house. I am not sure how to quantify that though.

In terms of capital growth, I am not sure if we will see the 7% average growth that we have seen in the past, in a higher inflation environment. In a constant low inflation environment, it could be lower on average.

My guess would be that we could expect capital growth of about 5% going forward. That would leave yields decreasing slightly over time.

Cheers,

House_Keeper.

[XBenX]

If we expect inflation to be 3%, we can conservatively assume wages growth to be running at 4%. This means that rents should grow by 4%.



I dont know how "conservative" that assumption is... there is a whole lot of variables that impact that statement.

Can you explain to me your line of thinking? Dont forget the real rate of inflation...

[Aceyducey]

In terms of capital growth, I am not sure if we will see the 7% average growth that we have seen in the past, in a higher inflation environment. In a constant low inflation environment, it could be lower on average.
House_Keeper,

7% growth is not a fully accurate figure.

Sydney & Melbourne have averaged closer to the 10% mark over the past 25 or so years.

Inflation has gone up and down over that period, so the concept of 7% average growth not holding in a 'low inflation' environment is a big reach.

For instance, look at the inflation rate vs CG over the last five years......we HAVE seen high CG for property in a low inflation environment.

That's been the 'normal' progression of the housing cycle versus the 'normal' progression of the inflation cycle....if you can consider each normal.

Now, according to past experience, there should be a period with little or no growth & some retracing....then another rapid spurt in property CG.

Whether this does or does not occur will only be minimally influenced by inflation rates IMHO.

Cheers,

Aceyducey

[House_Keeper]

I dont know how "conservative" that assumption is... there is a whole lot of variables that impact that statement.

Can you explain to me your line of thinking? Dont forget the real rate of inflation...
I could be wrong, as I am not an economist, but my understanding is that, over the long term, wage growth = inflation + productivity growth.

Hence, assuming an average inflation rate of 3% and productivity growth of 1%, we get an average wage growth of 4%.

[Aceyducey]

Hence, assuming an average inflation rate of 3% and productivity growth of 1%, we get an average wage growth of 4%.
House_Keeper,

Real life isn't that cut & dried :)

Cheers,

Aceyducey

[House_Keeper]

House_Keeper,

7% growth is not a fully accurate figure.

Sydney & Melbourne have averaged closer to the 10% mark over the past 25 or so years.

Inflation has gone up and down over that period, so the concept of 7% average growth not holding in a 'low inflation' environment is a big reach.

For instance, look at the inflation rate vs CG over the last five years......we HAVE seen high CG for property in a low inflation environment.

That's been the 'normal' progression of the housing cycle versus the 'normal' progression of the inflation cycle....if you can consider each normal.

Now, according to past experience, there should be a period with little or no growth & some retracing....then another rapid spurt in property CG.

Whether this does or does not occur will only be minimally influenced by inflation rates IMHO.

Cheers,

Aceyducey

Aceyducey,

What you say makes sense, but I'm still a bit confused :confused:

What were the rental yields 25 years ago? Now they are around 4%, and I understand we are below the long-term average.

Am I correct in assuming the rental yields are likely to be fairly stable over the long term?

Am I correct in assuming that rental growth over the long term is based on wage growth?

Then if on average inflation is 3%, wages growth is 4%, rental growth is 4%, and capital growth can't be too far from 4%.

Either one of my assumptions is wrong, or the original premise of this thread (3% inflation and 7% capital growth long term) is incorrect.

Any suggestions on which one it might be?

Cheers,

House_Keeper.

[Aceyducey]

Am I correct in assuming the rental yields are likely to be fairly stable over the long term?

Am I correct in assuming that rental growth over the long term is based on wage growth?

Then if on average inflation is 3%, wages growth is 4%, rental growth is 4%, and capital growth can't be too far from 4%.

Either one of my assumptions is wrong, or the original premise of this thread (3% inflation and 7% capital growth long term) is incorrect.

Any suggestions on which one it might be?
Your assumptions are just that, assumptions.

The original premise of this thread - 3% inflation & 7% capital growth - was also an assumption.

Correct or incorrect is relative.

What is correct in Melbourne burbs will be incorrect in Perth cbd.

Do not rely on national figures when calculating local markets - or you'll fall into the same error as L Bernham!

Use the appropriate historic figures for the locale you are purchasing in for a better guide to CG & rental return over time. And modify this by the changing demographics & infrastructure....then take your best guess :)

Cheers,

Aceyducey

[House_Keeper]

Thanks for the reply Aceyducey.

I have gone through the whole thread again and I am starting to make sense of what is going on.

I can see now how the national average may stick to average growth while some specific markets, like inner-city locations may have both higher capital growth and rental growth due to strong demand and limited supply.

Thanks a lot for helping me clarify that. :)

Cheers,

House_Keeper.

[Aceyducey]

BTW just a small comment on wages growth.

According to the latest statistics, the Australian average wage has risen 5.47% in the last year.

That's compared to 2% for inflation.

In the last 5 years average wages have risen 32%.

That's WAY ahead of inflation!

Oh - and during the same period new car prices have fallen a smidgen over 8% - new car sales are way up as the relative cost of buying them is way down.....

Thanks ABC!

If you're wondering why your dollar doesn't buy so much at the supermarket....I recollect that the latest food price figures show that food prices for the average trolley load are up 10% in the last year.

Inflation has many different components, often heading in different directions at different rates. It's why a raw inflation figure really doesn't bear that much relation to your day-to-day living costs.....or ultimately to property prices!

Cheers,

Aceyducey

[qaz]

Wouldnt the tax situation have a huge impact on yields?. If there are less tax advantages involved in investing in property (such as negative gearing), investors leave the market and yields go up to compensate.