Is Rental Yield A Good Indicator Of Where To Buy Investment Property?

Recently an article appeared in the Newcastle Herald titled "Newcastle Suburbs Are Delivering Newcastle Landlords Some Of The Highest Rental Yields In Australia".

Our ears pricked up and we shared the article on social media with some additional comments. It also provided some fuel for this post. While rental yield figures can provide an interesting indicator of a suburb's viability for investment, as is usually the case there is more than meets the eye with this statistic and often the finer detail is not considered. 

Let's start by understanding what rental yield is.

What Is Rental Yield?

​Rental yield is a measure of how much cash an income generating property asset produces each year as a percentage of that asset's value. Put simply, it is the annual rental income divided by the property's value, and expressed as a percentage. 

For example, if a property is rented for $400 per week and the value of the property is $500,000 then the gross rental yield will be $400 x 52 wks ÷ 500000 x 100 = 4.16%.

The term "rental yield" is commonly used in place of the more correct term "gross yield". Gross yield means that the rental yield figure does not take into account such items as insurance, maintenance and repairs, property management fees, depreciation, and so on. These items are of course relatively difficult to calculate across a broad suite of properties, and so are far less often referenced when calculating yield figures. 

Why Is Rental Yield Important To Consider When Investing?

​Generally, a high rental yield indicates good cash flow for the investor. Not only does this help with paying the loan for the investment property, this income stream can assist with securing additional loan approvals to expand the investor's property portfolio. 

For many investors though, the value of a high rental yield is not simply the cash flow, but the likelihood that this is a precursor to strong capital growth from the property. 

Let's explore this. When you think about it, renters are more nimble than property purchasers. They are operating on a more short-term basis e.g. a 12 month lease rather than a 20 year mortgage. For a renter, it is a lot easier to move than if you are an owner-occupier. 

For this reason, renters will be the first to move when a suburb begins to increase in its attractiveness. But since renters are not purchasing, the increased rental demand (driving rental asking prices higher) is not immediately reflected by higher property prices. This results in higher yield.

In time, investors and owner-occupiers will of course also notice the attractiveness of the location, but they are slower to move than the rental market. As property prices increase over time through increased demand to purchase, capital growth mounts for those who purchased earlier. But the lead indicator was the rental yield.

Is Rental Yield Always A Good Indicator of Future Capital Growth?

Just like any other figure when considering an investment property purchase, rental yield should not be looked at in isolation. Rental yield alone will not tell the complete picture of the viability of an investment property. 

Remember that the yield is a percentage of rental income over an asset's value. High yield may be a precursor to capital growth, or it may be that the property prices are not increasing (and not likely to any time soon). 

Why would this be the case? High yield may occur in an area where rental interest is high but owner-occupier interest is not. This has occurred in many mining communities and areas where there is a concentration of housing commission homes. People may wish to rent there to be close to family for example, but owner-occupiers may not wish to purchase to live there themselves.

In general, high yield represents strong interest from renters compared to purchasers. The important consideration is whether rental interest is likely to shift towards buyer interest in time as well. If so, rental yield can be a good lead indicator of capital growth, but should be considered alongside other factors to determine return vs risk. 

If you're looking for a refreshing and personal approach to property management in Newcastle and Lake Macquarie, contact us today. 

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