When Rental Yield Is Not Enough
by Jane Slack-Smith
I was recently reading the latest Residex Best Rent Report, which was released a couple of weeks ago. There are some notable suburbs in the report showing amazing yields – in fact one suburb in South Australia has a rental yield of over 7% – but the predicted capital growth is not that hot.
That got me thinking… I am often asked what is more important – cash flow or capital growth?
Capital growth versus cash flow has been a hotly contested topic in property investing since the year dot and most people stand firmly in one camp or the other. On the other hand, I have always considered that both are important. After all, if I can achieve both then this allows me to build a portfolio without having large out of pocket expenses each month.
I also believe there is a third way of making even more money.
The Trid3nt Strategy® allows you to make money in three ways; it’s like having a Plan A, B and C.
- Buy below market value.In a fast moving market this can be difficult, however the principle is that by doing your research you can identify opportunities and negotiate to create equity from the start.
- Buy a property with renovation potential.
This allows you improve the property so you have the potential to increase the property’s value and rent.
- Buy in an area with good capital growth potential.
As an area grows, you will get equity in your home and your property will be worth more when it comes time to sell.
As you can see, with this approach, rental yield alone is not everything. To be clear, you will not make money from a property based on a 5% to 6% rental yield unless you also have capital growth working for you. This is mainly because the cost of holding a property can quickly gobble up your income.
Costs include interest on your loan, council rates, strata fees, utilities, insurance and property management fees, just to name a few. A strong rental yield is important as it will minimise the amount of money you need to contribute out of your own pocket to cover these costs, hence why it is wise to target a high yielding area that also has good growth predictions.
Although there were many suburbs that interested me in the Residex Best Rent Report, there was one suburb that really stood out for me – Wallsend.
Wallsend is located in the western region of Newcastle (NSW), just 11 km from the city centre. The median house value is an affordable $413,500 with a rental yield of 5.04%. The suburb as a whole is also forecast to grow by an average of 6% per year over the next eight years, meaning it could be worth over $700,000 in eight years’ time. With fixed home loan rates below 4.8% at the moment, the median property in this suburb would not cost much to hold, particularly if you are able to make the most of negative gearing.
What really excited me about Wallsend was the Residex Renovators Report. There are over 95 streets in Wallsend that have renovation potential, where you could make over $50,000 by spending just 10% of the property’s value – generating a 20% profit. What’s more, of the 95 streets, 82 streets had the potential to make over $100,000 from a simple cosmetic renovation.
Before jumping into an investment purchase, it’s important to make sure you can easily rent out your property. There’s two parts to this – rental demand and vacancy rates. In the case of Wallsend, over 29% of the suburb’s population are renters and the vacancy rate is a low 2.6%, so both of these metrics check out.
This may not be the first time you’ve heard of Wallsend in recent weeks. If you have been following the news, you may have heard about the ‘big wet’ in NSW, and subsequently that Wallsend has been hit by floods. This brings me to an important point.
Numbers in isolation only tell part of the story. You need to use reports and predictions in combination with other data to conduct a thorough assessment. I believe as a final part of your research it is extremely valuable to actually hit the streets of the given area you are considering. Get a feel for the area, speak to local real estate agents, business owners, councils and residents to find out what is happening with the economy and if there are any plans for development in the area.
Natural disasters may be unavoidable, but knowing that they can happen and understanding the particular areas that are prone to natural disasters – in this instance flooding – should be part of your analysis.
The recent floods in Wallsend should not discourage you. After all, property is a long term investment. This current situation should remind us that there are always other risks to consider when conducting your research. When looking at a specific property it may pay to speak to insurers to make sure you can get appropriate insurance cover at a reasonable cost.
So, going back to the original question – What is more important yield or growth?
As you can see, rental yield is definitely something that should be considered but it is not everything. Capital growth is also important as it will allow you to sell at a profit. Combining this with renovation you also have the ability to push up the rent in the short term and hence reduce your out of pocket expenses, but the numbers alone are sometimes not enough (as recent events have shown).
The fundamentals, though, ring true. If you buy the right property in the right area and add value through renovation and capital growth, there is even the possibility of creating enough equity to buy another property and replicate your success.
Jane Slack-Smith is the Founder of Your Property Success online education – which teaches home owners and investors how to find the right property at the right price, and is the Director of the award winning Investors Choice Mortgages. Jane is also the author of Your Property Success with “Renovation: 2 properties, 1 renovation $1million in the bank”
The information contained in this article is intended as a guide to some of the important considerations when looking at owning an investment property. Although the author believes that the statements are correct, you should seek independent advice regarding your own specific situation. Neither the publisher nor any people or organisations involved in the preparation of this material give any guarantees about its content or accept any liability for any loss, damage or other consequences that may arise as a result of any person acting on or using the information and opinions contained in this article.