Rental Yields: Are they an accurate measure for analysing investment property? [Question]

31 May 2021

Most recent ATO statistics show the cost of negatively geared rental properties had climbed to $13.1 billion in the 2017/18 financial year. In 2017 the proportion of negatively-geared properties fell to 60%. If the majority of properties in Australia are costing investors money then why are the rental yields always positive?

Rental Yields

The way that yields are calculated are at the core of the reason. Gross rental yields are calculated by dividing the annual rental income with the property value. The net rental yield is calculated by deducting the annual costs (This includes council rates, strata fees, insurances, vacancy rates, agent fees, repairs and maintenance) from the annual rental income. Dividing that figure by the property value.

The only issue here is that the net rental yield calculation fails to encompass the biggest cost in property ownership, mortgage repayments. This is because every purchaser’s finance requirements and capacity are always different. It would be too difficult to assume the deposit amounts, varying interest rates across banks and whether it is a interest only or principal and interest loan. If the rental yield doesn’t truly encompass the true profit and cost of property investment, then why is this considered an important factor for any investor?

Investors like numbers, formulae, and calculations in order to have enough confidence to make a decision. Its not the investor telling the investor to purchase the property. Its the numbers that are telling the investor to purchase the property. That number which tells them “yes” or “no” is everything. The issue with rental yield calculations in residential property is the significant amount of assumptions made in order to achieve a single representative figure.

Commercial property where the value is derived from income/profit alone. Commercial properties are more comparable in the sense that they generally serve one purpose; facilitating commerce. There is no emotion or special value attached to the property.

Residential Property

Residential property is very different. No two properties are the same. The main method to derive market value is through making direct comparisons with other recently sold properties. This need to be in proximity and share similar physical characteristics and then determine whether the combination of these traits presents a more or less desirable property then place a numerical figure upon that. The weekly rental income is determined in the same way. This is an art within a science. But how accurate is assessing subjective notions of value and placing that into a single objective figure as an effective representation of value and the feasibility of a property investment?

Perhaps a better way to judge an investment in residential property, is by embracing the subjective nature of the residential property. Instead of relying on assumptions that break down characteristics to a single number. It should be based on rentability. An assessment of desirable and scarce factors that present the property as ‘one-of-a-kind’ can increase the ability for the property to attract prospective tenants.

In a tough rental market, these factors are what may make the difference in your annual rental income. Vacancy plays a bigger part in annual rental income than an investor may initially account for. Vacancy rates are assumed across the market and not reflective of the individual property. Based on a weekly rental of $550. If the apartment remains empty for just under 5 weeks of the year. It is the equivalent of a weekly rental of $500 for the whole year without vacancy. A high rental yield is only important as long as you have a tenant paying it.

Given the same potential rental return and property prices. I would pick a 1 bedroom apartment with no lift but never-to-be-built out beach views, than a run of the mill 2 bedroom apartment with 2 bath rooms with a big balcony and a lift but no view

Alexander Gibson

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