Rental Growth vs Property Growth



From: Fiona H

Hi all, herewith my first question (dont know where it disappeared to...)

If we assume rental growth at CPI (say 3%), as we do in PIA, and then we also assume capital growth at, say, 10% then it would seem that over the long term, rental return (ie, return on purchase price/value) diminishes.

Or, does rental growth actually equal capital growth in the long run? How long could this go on as the cost of accommodation (rental or buying) becomes a bigger and bigger component of our personal income? (who else remembers the days when even the brickies labourer had a holiday cottage, fully paid off?).

Has anyone had a property for say, 10-20years, who can comment on this?

Has anyone else puzzled on this and come up with some profound answers?

Curious - as it affects my forecasting/analysis of properties on a good day and completely perplexes me on a not so good one.

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Reply: 1
From: Donna L

For what it is worth, my theory on this is
that when the property is brand new you
have a "starting price". Tenants love to
live in brand new so the rental return is
good. But most of the capital growth
comes from the increase in the value of
the land whereas the rental return is
related to the condition of the property
which deteriorates (unless you are
renovating) and/or "dates". Bit like driving
the car off the showroom floor However,
in relation to the "initial debt" the rental
"return" should be increasing but it may
not continue to be 5 or 7% of the
increasing value of the property.

I hope this makes sense.

Donna L
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Reply: 1.1
From: Debra L

I thought it might be useful to give some real life examples.

I bought an IP in the northern suburbs of Adelaide in 1998 which rented for $100.00pw (now rented for $115.00 pw) and a second property that rented for $90.00 pw (now rented for $115.00pw).

The first property has increased in value at a compound rate of 35%, while the rent has increased at 4%.

The second property has increased at a compound rate of 32% and rent has increased at 7%.


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Reply: 1.1.1
From: Fiona H

To clarify:- Debra's example sums it up.

When she bought the property, lets say the rental return was around 5.2% (bulk standard $100/wk per $100,000 value). Now, if someone bought this property, rental return would only be around 4.4%.

Excluding the obvious (she got a fab deal, rental market is soft/pathetic at present) it is the long term trend of decreasing rental returns compared to property value that I'm interested in.
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Reply: 1.1.2
From: Glenn Mott


I feel that rents and property values move in different cycles. At the moment, the general economic situation and outlook is good, allowing more people buy and giving them more confidence.

In a few years time when interest rates have risen or other factors that cause the herd to sell or not buy investment investment properties, rental accommodation will become scarce and rents will rise until yields on these properties become enough to drag investors back into the market because they are purchasing cash flow (rent exceeding expenses on 100% financed props)

Hope this helps

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From: Gail H

Yes, I agree with Glenn. Capital growth tends to be cyclical. If prices stagnate for the next, say, 5 years (as they may do), then the rental yield will catch up somewhat. At the moment, its the worst because we've just had the longest property boom since the 50's.

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From: Michael Yardney

I've got a few properties that have been owned for many years and would agree with Gail and Glenn that capital growth and rentals move in different cycles.
Debra's example is from this part of the cycle where affordability is high (low interest rates, booming economy) so house prices are going up, pushed mainly by owner occupiers.
More people can more easily afford property and that is why the vacancy rate is so high (4.8% in Melbourne.) This means rents which have only risen about 5% in Melbourne in the last year have lagged behind capital growth rates (20% in Melbourne). The next stage of the cycle is increased interest rates and less affordability of houses. More people become tenants and slowly rentals which catch up.
I've ben following the real estate market since the late 60's and the cycle goes on.
It's not as clear cut today, and it's really hard to tell where you are in the cycle at the time. It's amazing how obvious it is when you look back!
Michael Yardney
Metropole Properties
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From: Les .

G'day Fiona,

I tend to think that Rents, like Capital Growth, are more tied to supply and demand than to the CPI index.

Thus, with the vacancy rate in Sydney at its highest level (ever?), it is a given that rental yields will be poor. Poorer still, because of the Capital Growth at this part of the cycle.

The CPI may well be sitting around 3%, but rents are dropping in Sydney at the moment because of the current vacancy rate.

In a year or so, even if CPI is still 3%, the vacancy rate should have returned to its usual < 2% rate, and rents will climb again.

Another likely factor that will push rents higher is this:-

With property prices currently "thru the roof" and rental yield historically low, all of the "swinging voter" investors that are looking for yield will drop out of property (back to shares, or cash) - this will reduce the number of rental properties available, thus helping the "supply/demand equation" (to OUR benefit ;^)

Good to hear from you again, Fiona - it's been a while,



- "Eschew Obfuscation" - ;^)
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From: Tibor Bode

Hi Fiona and everyone else,

I am currently using (refining) a method how I can figure out future value of a property
using the long term average (currently I have only 10 years, but try to get more than that) rental yield. What I mean, if I buy a property with 11% gross yield and the 10 years average yield is running for the property type in the same suburb(RESIDEX)
than it points to me that prices will catch-up when the cycle will take its course as was discussed earlier. A simple example.
Property cost $45000 with 11% ($4950) yield at purchase. Average yield for property of suburb in question is 8%. I would expect that with time ("sanity prevails") the long term average will come back (or close to it)
It would mean that the property will value
to $61875 ($4950 / 8%). Obviously there are several factors which can effect this figure and there is no exact timing, but I am using it on the basis the "numbers tell me a story, I just have to listen to it". It seems to me that on a rough basis this is working well for me, but obviously only time will tell how accurate the figures are.

Some food for thought.

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From: Jeremy Laws

You should be able to do that immediately with your bank. Try the argument that if it is yielding 8+% then by default the property is commercial and should thus be valued as a commercial property. ie as a multiple of yield, rather than the traditional residential method. Its worked for me for years...
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From: Tibor Bode

Thanks Jeremy,

Just the words, I wanted to hear. This is my dream to have my portfolio valued on rather a commercial than a residential basis. I am trying to use methods (multi year lease agreements, yield based property valuation, professional presentation and arguments) for this, but not with great success. My previous broker just repeated that the banks do not want to revalue in less than 6, but preferably in 12 months. As the majority of my current loans fixed at 6% for 2 years, at this moment in the cycle I do not want to rock the boat, but when the time comes up..
as well as on my recent purchases which are variable, so I have the freedom to move.
Do you have any lender (or the lender senior manager) you use who is willing to listen to the FACTS not biased by his / her OPINION?


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From: Mark Laszczuk

Does anyone out there think about or actually use the idea of basing rental yield purely on purchase price, even twenty years down the road? I mean, cap growth is nice, but ultimately it's a perceived value. What I mean by that is that I believe that something is only worth what someone else will pay for it. It's all very good to have the valuer tell you it's worth $x and I too would use this figure for various other things (like accessing equity), but if someone is only prepared to pay maximum 10K less than the given value, what is the true value? Anyway, I guess what I want to know is are there people that stick to their purchase price for rental yield, since that's what they paid for the house?

'no hat, some cattle'
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From: Sim' Hampel

I use rental yield as a comparison of the relative costs involved in holding a property when I purchase it. It is really only useful at purchase time, as there are too many other variables which come into play over the longer term, such as ongoing costs, maintenance and interest rate fluctuations.

Because of property cycles, rental yields will change over time with the "value" of the property... as we're seeing at the moment during a period of rapidly rising property prices, yields plummet. They will start to catch up again in the future as property values stagnate or even fall back from their highs.

You need to think really carefully about what this information called rental yield actually means, taking into account the context of what numbers are used and what information you are actually looking for.

Personally, I calculate rental yield purely as the gross annual rent divided by the purchase price (excluding purchase costs). This is a simple calculation, and allows me to compare between various properties at purchase time, but after purchase it starts to lose its meaning.

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From: Tibor Bode


basically I do the same, but as I mentioned on another thread I use the 10 year yield to get an indication (apart from several other things) how much gain or loss could I expect
in a "statistically stable" world. Of course this does into exist, but the "back calculated" property value (based on 10year yield divided into the purchase price without costs)seems to me provides a reasonably good indicator. Obviously give me another 10 years so I can present it as a FACT as currently it is only my OPINION.

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