If your are considering buying an investment property in the next 6 to 12 months you should read this information about the correlations between rental yields and property price growth.
Demand from investors contributes greatly to the state of any property market; and with their focus largely on returns on investment such as rental yields, we should look at the correlation between rental yields and capital growth.
This is a somewhat complex relationship as we shall see below, and it needs careful examination to fully understand how we may be able to determine where we are in the property cycle from the value of rental yields.
A typical rental vs. investment scenario
When rental yields are high it usually presents opportunities to buy. Investors are obviously attracted to the higher returns on investment, and typically higher rental yields for investors also mean higher rents for tenants.
This will often get to a point where renters will start assessing the viability of buying rather than renting, which again affects the overall market.
But then, as property markets move and more owner-occupiers and investors decide to buy, property prices are often pushed up faster than rents increase. This has the effect of reducing rental yields. It helps to look at a typical example: Say a property rents at $600 per week. That’s $31,200 for the year. Suppose the property is valued at $550,000.
You work out the rental yield by dividing the income per year by the value. So in this case it is 5.67% (i.e. $31,200 ÷ $550,000 x 100 = 5.67%).
Suppose demand in the market from owner occupiers and investors experiences a boom. This might raise the property’s value to $600,000. However, the rent stays the same. This causes the rental yield to fall to 5.2% ($31,200 ÷ $600,000 x 100 = 5.2%).
In this case then, the rental yield falls to a less attractive rate for investors independent of an actual change of rent; conversely if property values dropped and the rent remained the same, the rental yield would be higher and more attractive to investors.
What is the ‘property cycle’?
Between 2000 and 2003, rental yields in Australia were generally between 5% and 7%. When the market started booming and property values increased, yields dropped to around 4% per annum.
This made it more difficult to buy into the market. When the price increases continued and yields started going below 4%, the market could no longer tolerate it and it resulted in fewer people exiting the rental pool and fewer investors prepared to buy.
The result? More people start renting again and pressure increased to raise rental prices, which starts to bring yields higher again.
Yields may rise to a level where it becomes attractive to investors to buy again, and that would complete the ‘property cycle’.
What can we determine from rental yields?
At present, rental yields for houses around Australian states vary between 3.5% and 6.50%; home loan interest rates are approximately 4.5%.
According to CoreLogic/RP Data research, rentals grew more quickly than property values between 2007 and 2013. This ‘gap’ generally creates conditions for the property market to rise with more renters looking to enter the market and more investors attracted too. Of course, these factors do not work in isolation from economic growth factors, low interest rates, the value of the Australian dollar and demand from overseas investors.
Taking Sydney (above) as an example, rents rose by 35% between 2007 and 2013, outstripping property values, which grew by 20%. Strong capital growth conditions started to kick in, attracting both investors and owner-occupiers, which we would expect to cause an increase in property values.
In Melbourne the situation was rather more balanced – with rents and capital growth increasing by around 20%; according to what we know from the above, we would expect this to produce less of a spike in property values than in Sydney.
For Brisbane, house prices actually fell by 3%, while rents grew by 27%. We would expect the high rentals to potentially raise property values there.
What has actually happened since 2013?
The figures below show what has happened to property values (and rental yields) in the three largest Australian cities from 2013 up to March 2015.
|Price growth June 13 to June 14||17%||10.3%||6.9%|
|Price growth June 14 to March 15||12.6%||5.05%||1.9%|
|Rental yield @ Feb 2015||3.5%||3.2%||4.5%|
The above illustrates the relationship between growth in property values and declining rental yields.
Low rental yields are now evident in Melbourne and Sydney, with property values outstripping rentals, especially in Sydney, where we may soon see rental yields driven down below Melbourne levels.
Even though property values are rising considerably slower in Brisbane, the total return is not far from Melbourne’s because of the much healthier rental yield.
Whilst investor focus has been largely on Sydney and Melbourne because of the significant capital gains there, and in spite of the low rental yields, we are starting to see this focus move to Brisbane. We believe that in the interests of a balanced, long-term investment strategy that considers both capital growth and rental return,the Brisbane market represents the best investment value proposition at present.
The chart below shows capital city property values as at June 2012 and also the BIS Shrapnel forecast values at June 2015. Well as at March 2015, Sydney’s median house price was $914,000 (their forecast was $750,000), Melbourne is $638,000 (their forecast was $557,000) and Brisbane was $484,000 (their forecast was) $515,000.
Whilst Sydney and Melbourne property growth has been very kind to all holding property in these cities, the run will not last forever and they have now has overshot most forecasts.
As an established and experienced buyers agent Pillar Property scans the market for the best possible investment properties for our clients. We can provide invaluable and independent property advice to help our clients purchase the right property, in the right location at the right price.