What is a Healthy Rent Yield?

[Able]

There is an incredible amount of "noise" in the media on housing affordability. I know the media can tend to over sensationalise, on occasions, but IMHO affordability is an issue that is only set get worse into the future. I am mainly referring to Sydney.

Forecasters expect the rental squeeze to continue for at least several more years. There are also a number of ideas out there for encouraging cheaper rental accommodation. It cracks me up when commentators or the media in general carry on as if rents are really expensive and what can be done about the “crisis” when I hold the opposite view; rent yields are still low and need to increase, and this is a main contributor to the whole rental shortage problem.

All of this prompts the question, WHAT IS A HEALTHY RENT YIELD, not just for investors but for the property market as a whole.

My view is that rent yields are still quite low as they have not kept pace with property value growth over the last 10-12 years. There is still some way to go with rent yield increase until some sort of equilibrium (supply and demand of rental property) is restored. While this happens I find it hard to see how we rental property will become more affordable. It is more likely to do the opposite.

Some investors will be attracted if there is a good prospect of capital growth, even if the yield is low. If the market was only driven by investors then there is a far higher prospect of capital growth when yields are actually high. However much of the market is influenced by owner occupiers rather than investors, so I accept that this reasoning may not hold. If the market is to only achieve a mediocre but sustainable (over the long term) capital growth then I would not want to invest into low yielding property. The overall IRR (internal rate of return) would not stack up. Yields would have to increase somewhat before I seriously re-enter the market. There are probably many other investors with a similar view, hence the current “rental squeeze”.

I would be interested on the thoughts of others.

Regards
Able

 

[BDM]

Hi Able,

I guess it's all relative - what may be "a healthy rental yield" for some might be unhealthy for others, and yet also might be "super fit and astounding" for others again.

Some investors are happy with a < 3% yield, and others will not purchase if the yield is under 12%. Each to their own, I suppose, given that everyones circumstances and requirements are different.

Similarly with tenants. Some will only pay / can only afford $50 per week, others are happy to slap down $1000 per week if they feel they are getting good value for their money.

From an investors point of view, I think it is important to target a specific type of tenant, and buy accordingly. If that means targeting rich "Gen-Y" single people, then buy inner city apartments, and accept that the yield may be low. If targeting lower income earners as tenants, then perhaps buy in outer suburbs, and accept that a slightly higher yield might mean a slightly lower potential for capital growth.

Thanks,
BDM

 

[TJamesX]

There is an incredible amount of "noise" in the media on housing affordability. I know the media can tend to over sensationalise, on occasions, but IMHO affordability is an issue that is only set get worse into the future. I am mainly referring to Sydney.

Forecasters expect the rental squeeze to continue for at least several more years. There are also a number of ideas out there for encouraging cheaper rental accommodation. It cracks me up when commentators or the media in general carry on as if rents are really expensive and what can be done about the “crisis” when I hold the opposite view; rent yields are still low and need to increase, and this is a main contributor to the whole rental shortage problem.

All of this prompts the question, WHAT IS A HEALTHY RENT YIELD, not just for investors but for the property market as a whole.

My view is that rent yields are still quite low as they have not kept pace with property value growth over the last 10-12 years. There is still some way to go with rent yield increase until some sort of equilibrium (supply and demand of rental property) is restored. While this happens I find it hard to see how we rental property will become more affordable. It is more likely to do the opposite.

Couldn't help biting on this one....

You mention that it cracks you up when the media carry on that rents are too high, and then go on to say that clearly rental yields are too low. Well you seem to be comparing two diferent things... one is an absolute number and the other includes the asset price as part of the ratio.

I am assuming you're talking about articles like;

http://www.smh.com.au/articles/2007/07/25/1185043120999.html?from=top5

People's capacity to pay rent is usually linked to their income - again which has basically no link to house prices. Do you suggest we should have rents increasing faster than wages? I think the latest ABS stats suggest they actually are.... so the RBA may have to increase rates.... which hurts yields more

What cracks me up is no one ever seems to question the price paid for the assets when complaining about rental yields


We had a house price boom - but forgot to build more houses

No ones building any more because people can't afford to buy

So we are in a real mess

and negative gearing failed

IMVHO

TJ

 

[alexlee]

A healthy yield is whatever allows me to hold the property for the long term while watching the property appreciate.
Alex

 

[Able]

Couldn't help biting on this one....

You mention that it cracks you up when the media carry on that rents are too high, and then go on to say that clearly rental yields are too low. Well you seem to be comparing two diferent things... one is an absolute number and the other includes the asset price as part of the ratio.

I am assuming you're talking about articles like;

http://www.smh.com.au/articles/2007/07/25/1185043120999.html?from=top5

People's capacity to pay rent is usually linked to their income - again which has basically no link to house prices. Do you suggest we should have rents increasing faster than wages? I think the latest ABS stats suggest they actually are.... so the RBA may have to increase rates.... which hurts yields more

What cracks me up is no one ever seems to question the price paid for the assets when complaining about rental yields
TJ

TJamesX
Maybe i should have explained further. I am saying that on one hand the media talks about high rents generally across the market, and what can be done to make renting more affordable. But on the other hand we low rent yields (i am talking in very general terms), hence less investors attracted to the market in recent times, and a resulting shortage of rental properties which is helping drive rents up.

Your next point about peoples capacity to pay rent is also interesting. I will turn the question around. Do you suggest that rent returns can have basically no link to house prices? I put forward a scenario where wages growth over the long term is say 4% (i don't know what the actual forecast growth is). Who thinks Sydney property will grow at greater than 4% over the long term? Probably most people. If so then rent yields will keep decreasing along with supply of rental accomodation. The principal of supply and demand would suggest the opposite, that rent yields (and therefore rents) will increase.

Regards
Able

 

[Able]

Couldn't help biting on this one....

You mention that it cracks you up when the media carry on that rents are too high, and then go on to say that clearly rental yields are too low. Well you seem to be comparing two diferent things... one is an absolute number and the other includes the asset price as part of the ratio.

I am assuming you're talking about articles like;

http://www.smh.com.au/articles/2007/07/25/1185043120999.html?from=top5

People's capacity to pay rent is usually linked to their income - again which has basically no link to house prices. Do you suggest we should have rents increasing faster than wages? I think the latest ABS stats suggest they actually are.... so the RBA may have to increase rates.... which hurts yields more

What cracks me up is no one ever seems to question the price paid for the assets when complaining about rental yields
TJ

TJamesX
Maybe i should have explained further. I am saying that on one hand the media talks about high rents generally across the market, and what can be done to make renting more affordable. But on the other hand we low rent yields (i am talking in very general terms), hence less investors attracted to the market in recent times, and a resulting shortage of rental properties which is helping drive rents up.

Your next point about peoples capacity to pay rent is also interesting. I will turn the question around. Do you suggest that rent returns can have basically no link to house prices? I put forward a scenario where wages growth over the long term is say 4% (i don't know what the actual forecast growth is). Who thinks Sydney property will grow at greater than 4% over the long term? Probably most people. If so then rent yields will keep decreasing along with supply of rental accomodation. The principal of supply and demand would suggest the opposite, that rent yields (and therefore rents) will increase.

Regards
Able

 

[alexlee]

Your next point about peoples capacity to pay rent is also interesting. I will turn the question around. Do you suggest that rent returns can have basically no link to house prices? I put forward a scenario where wages growth over the long term is say 4% (i don't know what the actual forecast growth is). Who thinks Sydney property will grow at greater than 4% over the long term? Probably most people. If so then rent yields will keep decreasing along with supply of rental accomodation. The principal of supply and demand would suggest the opposite, that rent yields (and therefore rents) will increase.

Regards
Able

To be fair, TJamesX didn’t say rental yield have no link to house prices. He said that rents (i.e. rental amounts) have no direct link to house prices. How much rent a person can pay is dependent on income, not house prices. Just because house prices increase doesn’t mean we can suddenly pay more rent.

Can property prices grow faster than wages? Yes. Can RENTS (amount) grow faster than wages? Again, yes. The reason is the same: suburb creep. The type of person who lives in a certain suburb changes as time goes on. What used to be an outer suburb populated by blue collar workers making the average wage, say, becomes a mid-ring suburb populated by white collar people, who make more than the average wage. The later blue collar workers then move to the outer suburbs of THEIR generation. There is also redevelopment (houses into units, say) which ‘resets’ the rental amounts and yield.
Alex

 

[TJamesX]

Can property prices grow faster than wages? Yes. Can RENTS (amount) grow faster than wages? Again, yes. The reason is the same: suburb creep. The type of person who lives in a certain suburb changes as time goes on. What used to be an outer suburb populated by blue collar workers making the average wage, say, becomes a mid-ring suburb populated by white collar people, who make more than the average wage. The later blue collar workers then move to the outer suburbs of THEIR generation. There is also redevelopment (houses into units, say) which ‘resets’ the rental amounts and yield.
Alex

That pretty much sums up what I was going to reply with.

In essence the increase in rental for the average house should not (over the long term) outpace the increase in average household income. However for one specific house, it's status will change over time from average, to a little above average to above average as a city grows - so you would expect the rent for a specific house to outpace equivalent household income growth... but obviously this depends on the growth rate for a city

However this does not account for the current very low yields as this was driven by house prices rising much more rapidly than real wages and rents (much of it I believe related to lowering credit standards and lower interest rates - both of which are not guaranteed to last forever)

So you would expect all other things being equal the yields will improve as a result of rents increasing faster than house prices

TJ

 

[alexlee]

I think at the moment, especially in Sydney, we're just seeing rent playing catch up to prices. When the recession comes (and it will) prices will fall a bit. Rents may not necessarily go down, because population is increasing and we're underbuilding.

An interesting point in Ross Gittins' article in the SMH today was that as dual-income families become the norm, then purchasing power (and rent) becomes based on two incomes. That is, it explains why in the last generation houses were only 3-4 times wages while now it's 7-8 times: it's because enough couples are both working that the AVERAGE household income is now dual.
Alex