When I first started investing I had no idea what a rental yield was or what it meant for investing or how to work it out. I was a real property dummy. I knew that the rent was needed to help pay the mortgage, but that was about it. After buying my first investment property a few years ago and having Ian Hosking Richards as my mentor as I grew my portfolio, I now get it. However as a property advisor, I am mindful that there are many other investors who do not get it either. I have found that there is lot of misconception out there about what rental yields really tell us when selecting a property as a suitable investment.
Calculating the Yield
To work out a rental yield, the weekly rent X 52 weeks, is divided by the purchase price. A quick way to work out a yield in your head is that 5.2% yield is approximately $1 of rent per $1000 of price. Example 5.2% rental yield on a property at $400,000 purchase price would be $400 a week rent. ($400 X 52 = $20,800 divided by $400,000 = 5.2%). In my experience a yield of 5% can give a positive cashflow outcome and a yield of 8% can give you a negative cashflow outcome. Surprising isn’t it? This is because there are many other factors that affect a property’s cashflow. There is more to the story than just gross rental yield.
The higher the rental yield the better the investment opportunity?
Logic would tell us that the above statement should be true. A property purchase price of $400,000 with $620 a week rent has a rental yield of 8% .In this instance you have more income from rent to service the expenses of the property. Sounds great, should I rush out and buy it? It sounds like a positively geared property.
As a property advisor I know there are many other boxes that need to be ticked before rushing into a purchase.
Capital growth vs cashflow vs risk
The above 8% yield sounds ideal. If it was that easy we would all be happy. However there is more to the story. Selecting a property for high yield alone can have some consequences. Many investors have found that high yielding properties can come at a cost of little capital growth, negative cashflow or increased risk.
I have spoken to many investors who bought a property based on the yield alone only to find that the area they selected stayed stagnant for years, with no capital growth achieved. Without capital growth their ability to grow their portfolio came to a crashing halt. So assessing a property for potential drivers of capital growth as well as yield becomes critical for your portfolio growth.
Other investors decided to buy a cheaper property, based on affordability and the promise from the agent that it would be positively geared. They then found that the costs of holding the property were much higher than first thought due to continual repair and maintenance costs of the property, eroding their anticipated cashflow. So assessing a property for potential cashflow as well as yield becomes of prime importance.
The promise of high yields from 8% - 15% can be found in many mining areas in Australia, particularly in Qld and WA. Reading the advertisements for properties in these areas and the high rents being achieved makes them appealing to investors. However with high returns comes high risk. Volatility in the market is to be expected .A new investor wanting to start their portfolio may find the risks too high until they have more experience.
Assessing Cashflow for a property
The assessment criteria when selecting a property should be based on more than just rental yield alone. Gross rental yield is not a reliable indicator of whether a property will have a positive or negative cash flow, will have future capital growth or will be a high risk investment. As well as the due diligence and research required to assess the potential for growth and the level of risk, I recommend that a simple Rocket Cashflow Estimator talking account of the rent and anticipated expenses can give a much more reliable indicator of whether a property will make a great addition to your investment portfolio. If you want to see examples of how a property with a yield of only 5% can have a positive cashflow outcome please give me a call. Helping investors is what I love best!
Lindy Lear is a successful property investor who had a late start into investing, yet has grown her portfolio to eight properties in three years. She is a qualified property advisor and general manager of Rocket Property Group, and she won the Reader’s Choice Award in 2009 for Property Investment Advisor of the Year. Lindy is passionate about helping others realise their goals through investing in property, and can be contacted at 02 8012 9669 or visit www.rocketpropertygroup.com.au
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Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.