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rental yields are irrelevant for property investors

Discussion in 'General Property Chat' started by standtall, 19th Oct, 2015.

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  1. standtall

    standtall Well-Known Member

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    I am not disputing the mathematical equation used to calculate rental yields (periodic cashflow in comparison to total value of the investment) but I think the whole concept of yield in the context of property investment just doesn't make sense.

    Why?

    Rental yield on its own means nothing for a RE investor unless you take your cost of investing/borrowing/expenses into account. Everyone talks about low yields these days without realizing that interest rates are also very low. A 4% yield may be excellent if you get an investor loan at 3.75% but a 7% yield could be bad if interest rates go up to 8% lets say. As investors, a lot of success depends on 'difference between your holding costs and your income from the asset being held'. Hence instead of rental yields figures being highlighted by economists to draw all sorts of conclusions, they should just report 'average yield margins'.

    yield margin = yield on your original investment - current interest rate regardless of market cycle

    if you are getting a positive yield margin on a property, you are doing yourself a lot of good and the only exception should be when you are looking for a negative yield margin for negative gearing purposes.

    What does everyone else thinks?
     
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  2. Mombius Hibachi

    Mombius Hibachi Well-Known Member

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  3. radson

    radson Well-Known Member

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    I think everyone on this forum knows roughly the cost of money and is implied in any conversation on yields.
     
  4. DaveM

    DaveM Adelaide Buyers Agent & KFC Strategist Business Member

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    Perhaps
     
  5. Scott No Mates

    Scott No Mates Well-Known Member

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    Capital gains = delayed gratification. I want it now!
     
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  6. jins13

    jins13 Well-Known Member

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    Hmmm not sure what to say about this.
     
  7. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    Consider why interest rates go up. It's basically a result of the RBA wanting to cool down a hot economy to reign in inflation. Inflation also means increasing incomes which also leads to increasing rents.

    It's not always a universal rule, but certainly rents do increase over time and they tend to follow rates up. Rents can drop as well, but usually the long term trend is upwards. I do agree however that it's the capital gains that makes you truly wealthy, but you've got to have the cash flow hold it. My own protfolio does lean towards CG.

    On it's own rental yield is fairly irrelevant. People usually don't take into account other holding costs and mistakenly believe that a 6% yield is positive cash flow. It probably isn't after you take into account rates, management, vacancy, maintenance, etc. The formula describe by the OP suggests this erroneous thinking.
     
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  8. Rixter

    Rixter Well-Known Member

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    Gross rental yield is used as a quick ball park comparison of one IP versus another (costs being equal) as part of one's initial due diligence phase.

    As rightfully pointed out it is not one's bottom line.
     
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  9. Simon Hampel

    Simon Hampel Founder Staff Member

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    Good point by Rixter - it's a point-in-time snapshot of a property used for comparison. It means nothing over the longer term.

    The yields I'm getting on my block of units is something like 18% ... but that's based on rents now compared to purchase price 12 years ago - a rather meaningless figure. I've also redrawn equity against those properties to use on other investments, so my costs are much higher than what they were at purchase time anyway.

    Yield is useful - but only when comparing potential purchases and to work out holding costs based on current interest rates at the time of purchase (with some allowance made for increased rates in the future).

    After purchase, yield ceases to be a meaningful measure.
     
  10. Bayview

    Bayview Well-Known Member

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    I guess it's relevance depends how many zeros are on the end of your yearly PAYE.
     
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  11. norwoodman

    norwoodman Well-Known Member

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    I'd think that even yield margin would be of limited use to an investor, as this still ignores the impact of other expenses - two properties with the same yield margin in different locations could still have completely different cash flow outcomes. Even the same property leveraged differently would have different cash flow outcomes.
     
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  12. HUGH72

    HUGH72 Well-Known Member

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    I think I can see what your getting at. Consider a purchase for $126000 renting for 170 per week the yield is 6.9%. It the interest rate at the time was 9.0%, the yield margin would be -2.1%.
    Many years later the property now rents for 350 per week so the yield on original purchase price is now over 14%. It interest rates are 5% the effective yield margin would be +9%. Yields on purchase should be higher in a high interest rate environment in theory.
    I don't think its necessary to go to this sort of detail though, it's the final yearly holding costs or positve cash flow that matter.
    I think you can use yields to compare properties in similar suburbs or historical yields though as this might give a clue where the market is at currently.
     
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  13. Travelbug

    Travelbug Well-Known Member

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    I don't know any investor that would NOT take the cost of investing/borrowing into account.
     
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  14. Omnidragon

    Omnidragon Well-Known Member

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    Then you don't know enough people.
     
  15. standtall

    standtall Well-Known Member

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    Finally figured out how 'quote' works and thanks for all the attention ;)

    yes, spot on. I find that this particular comparison you mention is the utmost important thing because after 3-4 years, most property investment is a good one but performance in those early years allows investors to to grow faster or slower.

    I think you have simplified this beautifully - present cashflow would sum things as well without complex details. Cheers
     
    Last edited: 22nd Oct, 2015
  16. D.T.

    D.T. Adelaide Property Manager Business Member

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    Just a tip. You can highlight just the words you want with your mouse and a link saying Reply automatically hovers. This creates a post with the highlighted bit quoted for you. You can repeat as many times as you need and it quotes them all in the same post allowing you to put your replies inbetween.

    Don't be one of those people who replies to 4 different people using 4 posts :)
     
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  17. standtall

    standtall Well-Known Member

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    thanks, it works perfectly.

    hard to resist now that i know a cool feature ;)
     
  18. Travelbug

    Travelbug Well-Known Member

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    So you know people that do not take the cost of investing/borrowing into account when investing? That's scary. What ARE they basing their investing on? Guesswork?
     
  19. larrylarry

    larrylarry Well-Known Member

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    Great tip!
     
  20. See Change

    See Change Timing Lord Premium Member

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    We've specifically just bought a place because of it's 7.5 % yield . Aim is to pay it off and then we have an index pension . Less cost base to pay for , for the return .

    Cliff