Rental yields don't figure (article from the age)

[yieldmatters]

As you would guess I love an article about yield ...

http://www.theage.com.au/news/business/money/property/rental-yields-dont-figure/2009/07/27/1248546674116.html

But gross yields on most investment properties remain about 5 per cent. That is hardly a compelling rate of return, when the increase in property prices may well be short-lived.

Interest rates are probably on hold for another year or so, after which variable mortgage rates could well return to their normal levels of 8 per cent or 8.5 per cent from just under 6 per cent now.

During the boom, returns on just about all asset classes were out-sized and now most experts expect capital gains to be much lower on all asset classes. If investors are not adequately compensated by capital gains, they will expect to be rewarded with income.

Without the prospects of good capital gains, it seems odd that any investor would want to spend hundreds of thousands of dollars on something that yields about 5 per cent a year.

 

[wylie]

For us, the returns we get are fine, the capital gains have been very good, and seeing that our IPs are a secondary income, we are happy to take such low risk investing even if the returns are lower than other investments.

I believe I am not alone in thinking this way.

Of course, if it was our main source of income, we would perhaps feel differently, but knowing that the houses are paying for themselves, costing very little to run and pretty much hands-off (except when we choose to improve them - usually to get higher rent), I reckon they are a pretty good idea.

Then again, I wouldn't have a clue what our return is, 'cause my maths is bad, but the balance sheet is looking okay.

I always have a problem with investors that say renters are getting a good deal. Maybe I just don't think like a true "investor". I don't think most renters think that way. I think they believe they are paying "too much". I don't think they think like "investors". I think they just look at the $500 per week that they are paying to live in my house. I would not like to pay $500 for the house that I am getting $500 for. Maybe this is why we all feel kind of satisfied with our "lot".

They think they are paying too much rent, a pure "investor" thinks the landlord is getting paid too little rent for the money tied up, and as a landlord, I wouldn't like to be paying the rent that my tenants do for my own house.

 

[yieldmatters]

It makes no economic sense without capital gain. But at the very least providing you don't buy in at the peak of a cycle you should expect capital gain equal to CPI (i.e. flat real growth). So in that sense the return is a bit better than the article indicated (5% plus CPI of 2% would give you a nominal return of 7%). But as the article mentions the yield is gross so there are costs to come out of that. So maybe it washes up and 5% is what it is.

As for the renter I think they are getting a good deal. In property investing the value the investor receive comes from 2 sources: 1) The Rent less costs and 2) The next buyer of the property (capital gain). I would say in all successful residential property investments the majority of the value came from the second category (capital gain), not the first. So the concept of the renter making you rich is not correct - it is actually the next buyer.

 

[keithj]

As for the renter I think they are getting a good deal.

I'd agree the renter gets a good deal in year 1. After ~5 years of rental increases, it usually becomes a bit more balanced, and then by year 25, it's a no-brainer - renting is a big time loser.

In property investing the value the investor receive comes from 2 sources: 1) The Rent less costs and 2) The next buyer of the property (capital gain). I would say in all successful residential property investments the majority of the value came from the second category (capital gain), not the first. So the concept of the renter making you rich is not correct - it is actually the next buyer.

Probably agree in the earlier years - the renter pays our costs while we wait for the next buyer to come along. But in the later years, when the yield on purchase price (& corresponding debt) is huge it's a bit more even .

 

[wylie]

That may well be, but if the tenant is not making me rich, at least they are not costing me anything. They are allowing me to hold the property long enough to start turning positive (if in fact it started negative) and allowing me to hold an appreciating asset which I couldn't have done without the tenant. I do realise that this depends on how long the house has been held, and obviously, the longer held, the less that it costs.

In fact, I love it when the tenant starts putting more money in my pocket than I have to put into the bank's pocket.

Maybe this is why I don't mind at all what my yield is? That, and the fact that I don't know how to work it out anyway .

I still think the rent we are charging is too much for the house, but obviously the "market" doesn't think so, and I would be happy to make more .

 

[jingo]

The interesting thing with property investing is that there are so many ways to create a profit. The yield, although important to help with holding costs is just one angle of the investment. There are potential gains through capital appreciation (which the article doubts will be as strong in the future - hasn't that been said once or twice before ) then there are gains to be made through value adds - eg renovation, subdivision, development, paint and clean etc. Not to mention the tax incentives! There exists an ability to buy below market value - eg forced sales, etc.

Becoming fixated with holding costs is a reason many people don't enter the property investment market and seek advice from financial advisors who recommend investments like Macquarie managed funds, Westpoints etc. A decision that has cost some investors thousands of dollars in recent times.


Regards Jason.

 

[yieldmatters]

I'd agree the renter gets a good deal in year 1. After ~5 years of rental increases, it usually becomes a bit more balanced, and then by year 25, it's a no-brainer - renting is a big time loser.

Are you referring to real or nominal increases?

 

[Belu]

Jason (Jingo),

great post - would give you kudos but it wont let me!

my philosophy of late has been about generating gains, not waiting for CG to take its hold. Yes you may get CG by waiting 7-10 years but you may be able to gain that in 2-3 with some work.

Cheers,

Ben

 

[keithj]

Are you referring to real or nominal increases?

Doesn't matter. The debt & therefore the (average) interest bill will NOT go up with inflation. Rates, insurance (the other 10-20%) go up with inflation. Of course the income (rent) will go up with income. The bottom line is that 100% of the income goes up with inflation, but only 10-20% of the outgoings do.

From a renters POV, the outgoings starts (relatively) low & thereafter 100% of the outgoings will go up with inflation.

 

[yieldmatters]

Doesn't matter.

Of course it matters. You referred to rental increases making the renter worse off over time. Do you mean real rental increases (i.e. above inflation) or do you simply mean CPI on the rent? This is fundamental stuff when it comes to analysing economic data over time.

 

[eternit]

Doesn't matter. The debt & therefore the (average) interest bill will NOT go up with inflation. Rates, insurance (the other 10-20%) go up with inflation. Of course the income (rent) will go up with income. The bottom line is that 100% of the income goes up with inflation, but only 10-20% of the outgoings do.

From a renters POV, the outgoings starts (relatively) low & thereafter 100% of the outgoings will go up with inflation.

so I guess after a longer period RENTER is the biggest loser

 

[keithj]

Of course it matters. You referred to rental increases making the renter worse off over time. Do you mean real rental increases (i.e. above inflation) or do you simply mean CPI on the rent? This is fundamental stuff when it comes to analysing economic data over time.

Doesn't matter.... worst case is rent tracks inflation, best case is it exceeds inflation ('cos of urban sprawl, pop growth, etc).

Regardless, a business model where outgoings increase at ~0%pa, while income increases at inflation (or more) is better than the renters business model where outgoings increase at inflation or more. The low initial yield compensates the renter for the ongoing impost of perpetually increasing outgoings (regardless of whether they are real or nominal increases).

 

[Token Funder]

Doesn't matter.... worst case is rent tracks inflation, best case is it exceeds inflation ('cos of urban sprawl, pop growth, etc).

Regardless, a business model where outgoings increase at ~0%pa, while income increases at inflation (or more) is better than the renters business model where outgoings increase at inflation or more. The low initial yield compensates the renter for the ongoing impost of perpetually increasing outgoings (regardless of whether they are real or nominal increases).

So has rent been tracking inflation(I'm not sure your worst case is actually worst case)?

In my experience, the average punter seriously underestimate/forgets the holding costs of property. Depending on how honest I am with myself, each of the following could be a true statement of my PPOR:

350% increase on purchase price
300% increase on purchase price (deduct purchase costs and interest)
200% increase on purchase price (deduct purchase costs, interest, fees and maintenance
50% increase on purchase price (deduct purchase costs, interest, fees, maintenance and capital impprovements).

I tend to agree with Chris Joye from Rismark when he states their research suggest one in four property owners do their dough.

 

[steveadl]

300% increase on purchase price (deduct purchase costs and interest)
200% increase on purchase price (deduct purchase costs, interest, fees and maintenance

your fees and maintenance have added up to another 100% on top of the purchase price of your house?! Do you live in a wooden shack that blows down every storm TF?

 

[Ausprop]

It makes no economic sense without capital gain.

if your net holding costs are nil then then the deflation of debt must be a good thing.

this article seems to confirm that it's not different this time, hence no reason to think cap gains won't follow similar patterns to the past

As for the renter I think they are getting a good deal.

as does the borrower. It is the lender that gets the raw deal, more to the point the funder to the borrower i.e. people earning 2% in savings accounts. the other loser in this deal is the taxpayer who subsidises renters - but that is a whole new argument over who should fund housing costs

In property investing the value the investor receive comes from 2 sources: 1) The Rent less costs and 2) The next buyer of the property (capital gain). I would say in all successful residential property investments the majority of the value came from the second category (capital gain), not the first.

3) Deflation of debt in real terms. I would say this is the biggest category of gain

 

[craigb]

I see this investment class a bit different than others , specifically capital gains, where as its somthing i can get my hands on and directly add value to while others pay the loan

Is their another asset class that gives great capital gains and sombody else pays back the money for you? i don't thiink so!

 

[VYBerlinaV8]

Some good debate here!

I think yield is very important, because having sufficient cashflow to decouple me from paying the holding costs out of my own earnings means I am not really dependent on short term capital gain.

Over time, the rent increases, but my holding costs decrease, so the amount of $$ generated after tax grows steadily, independent of capital value. My plan has always been to own my IPs outright in the end, meaning I have plenty of assets to secure further investment borrowings, and rents coming in that aren't paying loan interest.

Ultimately, the question for me is not 'is property the best investment'?, but rather 'is property an easy, low risk way to generate substantial wealth and cashflow in the longer term'?

Fundamentally, rents increase over time whereas holding costs decrease. That gap is the benefit. Having decent yield to start with means there are fewer restrictions to how many IPs I can accumulate towards my goal.

(And don't forget, well located property with the right characteristics will still make capital growth in real terms over time).

 

[rugrat]

I see this investment class a bit different than others , specifically capital gains, where as its somthing i can get my hands on and directly add value to while others pay the loan

Is their another asset class that gives great capital gains and sombody else pays back the money for you? i don't thiink so!

This is exactly right.
Whatever anyone thinks about PI, having someone else pay for my retirement is a good idea.

The Property we are getting built is costing $418k - by the time the debt is paid off, I will have paid for none of that $418k or the interest on it - the rent will have covered it all and even earned a little extra along the way (this is all without considering any capital growth that may have occurred in this time). Not many investment where you can end up with something for nothing.

 

[DavidMc]

I am looking to invest again.

I have 55k to invest.

I have a pre-approval up to $450k for another IP.

With this I can buy a well located 2 bedroom unit with nil holding costs after tax (albeit at today's lower than average interest rate) with a 95% loan.

If not property what else should I invest in?

Shares being shares I'd prefer to only gear them up to 50%. Would $110k in shares be a better choice? Surely not?

I want to invest long term (15+ years).

The way I see it property is my best choice although I'm open to learn otherwise.

 

[tubs]

Rental yields are the rental return on the current property value.

But since people's original loans don't change, their return on their investment will continually increase as rents increase.

For example, a $300k house purchased 5 years ago might have had a 5% yield of around $300pw.

That house might be worth $450k now, and still be yielding 5%. This means the rent would now be $450pw, which is a 7.5% return on their capital invested. As rents grow, so does the investor's return.

5% is the return at the current time. Those who stay in the market will keep seeing their return on their money increase over time.