Is Rental Yield Really That Important?

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Did you just say 70?

 

Yes (110 tenancies) and going forward i still can't figure out which will give the best return (net yield plus CG)
It really is not easy to pick winners
(Combined growth and income over say 15+yrs)

 

So what are we talking, a half to three quarter Sydney house port ?

 

Yeah, if it was so easy to work out, we would all change our last names to "Buffet"

 

This doesnt account for the impact of 20K per annum redeployed towards debt reduction.... allowing for saved interest at far greater than 3%, and for the improved borrowing capacity multiplier effect that has over 20 years. I think I'd be waaaaaaay better off than 720K

It assumes the surplus money is not reinvested at anything better than 3%. It's the same as arguing that instead of reinvesting fully franked dividends at X, you should take them and bank them into an online saver at Y - ie less.

These arguments ( everyone's, not @Redom's) tend also to be underpinned by some assumption that growth will absolutely happen , and at the same or similar rates or cycles to the past 25 -30 years, which is far from certain. And further, that the equity from growth can then be harvested readily so that portfolio's can be expanded readily, another expectation based on experiences of the past 25-30 years , but also far from certain. In both cases, those arguments are hugely contentious and very likely flawed, if for no other reason than because we are at the beginning stages of a regulatory and political push that will have enormous consequences for the growth rates of the next 25-30 years

 

You can if you create that equity through debt reduction

I could invert the argument to "you cant continue accessing your capital for deposits if you dont increase your cash flow" and I think it would be more appropriate.

 

100pc agreed ...!

 

Hmm in general, 100% agree that debt reduction is key and will play a growing role for investors portfolios over time. Thats a great message for everyone to get used to, as it does directly contrast a decade of expansion in leverage and household debt levels in Australia.

Also agree that growth rates are likely to drop from past, borrowing capacities simply don't allow for it to continue without a fundamental shift in financing/demographics here (everyone starts working 60 hour weeks for example).

A quick 'back of the envelope' guide for Sydneysiders to think about.

• Every dollar of income increase will increase your borrowing capacity by about $7.
• Over the next 10 years, using CPI growth rate of 2.5% applied to your median wage. Note wage growth has been below inflation of late. Median wage increases roughly from $100k to $130k p.a. The extra $30k equates to around $200k in borrowing capacity.
• Over the next 10 years, using a relatively low growth rate (using past data) of 5%, the median house price will be ~1.8-1.9mill - a $700-750k increase.
• So on average, people will have a $200k borrowing capacity increase vs a $750k increase in house prices. Simply, where does the other $550-600k come from? Will people be able to save or generate that amount?
• Worse still, if we apply a CPI growth rate to housing, it equates to a ~$350k increase in prices. Still far more than the borrowing capacity increase.
• This assumes interest rates remain at current record low levels over a 10 year period too!

Of course this is a simplistic analysis. Its just looking at borrowing capacities as a driver of price growth. But prices are 'capped' (at least theoretically) by what people can afford to pay. Balance sheets are already stretched too.

 

In terms of investment strategies, IMO using $400-500k of your precious borrowing power to generate a 8-10k yield is small play IMO.

Its also pre 2014 thinking, based on having your 400-500k recycled time and time again to multiply the 8-10k yield.

As an investor, ask yourself, what are you trying to achieve here and what risk are you willing to take to get there? Financial freedom? How exactly is that going to work if you have $1-1.5mill in capacity and you use a third of it generating 8-10k in cash flow but achieve little/no growth? Also, how real is the cash flow? E.g. what happens when the $400-500k debt turns to P&I in 5 years time and rates are 6-6.5%? What happens when the building detoriates and maintenance costs rise? How much 'net' cash flow are you achieving over a 10-20 year period?

IMO, with all the changes in financing, investors need to get a little more creative with property to achieve goals. Noting that growth rates are unlikely to naturally be 4-5%+ anymore, how will you achieve your goals?

You can no longer build $4-5mill portfolios that pay for themselves. These portfolios that were built are great - build big, pay for themselves and watch the debt deflate over time with long run price growth.

They make for cool catchy stories that are worth writing about. This was a strategy of the past that has worked when well allocated. We've got a bunch of investors that have done this already and are doing very very well for themselves as a result. Some are going to retire soon with very nice nest eggs. Its a fantastic result.

But times have changed and investors can't actually expect the same playbook to work now, at least not as quickly. You can't build that portfolio size. Rates are rising, etc. Simply, aggressive debt accumulation with no plan for debt reduction doesn't work anymore.

Strategies need to 'evolve' to look at debt reduction/management over time.

Yield dividend reinvestment is one play sure.

IMO, a strategy far more likely to generate wealth over a shorter time period is to use your slightly lower borrowing amount (given yield difference), to generate a greater capital return. Use that capital return to pay down debt. There are pretty common ways to do 400-500k asset purchases and generate 50-100k cash returns. Some strategies that we see quite regularly, cheaper duplex builds (say in Adelaide), subdivisions of land (e.g. in Logan corner blocks), house & land constructions in moving markets (e.g. West Melb and West Syd), etc. There's a bunch of ways to do it.

 

Flipping is a good way to get profits, but the tax implication is huge as well, ATO could look at this in a different way, you might be hit with a huge tax bill.

 

If living in the property and claiming as main residence then you are exempt from CGT

 

Not everyone can do this. If you live and work in Sydney, you can not just stop your job and go and live in a property that is in Melbourne or Brisbane for a few months.

Also when you apply for the loan, if you apply for PPOR and not IP, they will loan you less, so if your problem is serviceability, then this defeats the purpose.

 

I read flipping as a renovate and/or add equity somehow.

Thought interstate were more buy/hold as you aren't near enough to them for good cost management of renovations etc

 

What tax implications? Wouldn't the profit be taxed at your marginal rate, such as a usual business profit? (No 50% CGT anyway if selling under a year)

I'm not an accountant but my understanding is that repetition and intent matter. So if you do it several times and the ATO picks up on it, they could argue that repetition establishes intent to make profit by flipping, then full CGT applies.

 

Great post!

@Redom - picky but you need to update your signature.

Problem with this is if your clients have the capacity to lend then they don't need to borrow . Your clients are borrowers not lenders.

 

Get rich by focusing on process not outcome

This is an article about the debt reduction I talk about so often.

 

Ditto...!! This what people forget.

You need CG in order to buy further. The good news is with falling interest rates...you may only need 4.5% returns to be neutral or positive.

Most NRAS stuff is very poor quality asset wise...

 

You need borrowing power tor cash to buy further .

Hip pocket yes, but not on a servicing calculator

You own how many? Ah, zero...that's right

 

I own quite a few NRAS's and agree that the actual underlying asset is a poor quality when viewed from a 'growth' prism, which is how many investors look at assets.

Typically low land content, high build content, new builds, etc. It's got nothing to do with NRAS though, so its not really a comment on the scheme itself. It's broader - its about purchasing new dwellings as investments in general. NRAS, is an incentive placed on an asset. The targeting of the scheme means that the incentive isn't really placed on 'growth' assets (e.g. high land content, slightly older builds, etc).

Hence, you're trading of far lower capital gains for yield. Yield is valuable and important for portfolio investors too. Yield offers a lot of safety, more recession proof, helps manage risks, etc. It's a very legitimate way to earn your return than lumpy capital gains over time & @euro73 provided plenty of useful strategies/comments to use yield to snowball greater impacts.

 

The outcome of CG vs CF ultimately depends on what someone decides to do with the cash or wealth generated.