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22 Mar 2018

The truth about good yield and bad yield

As the property price tide in Sydney and Melbourne starts to recede and with no real prospect of imminent growth in most of our other major housing markets, it’s little wonder that the focus of investors will turn to cash flow rather than equity. This will probably lead to a flood of webinars, events, articles and reports promising to reveal areas with the highest rental yields.

BAD YIELD IS CAUSED BY FALLING HOUSING PRICES

Unlike positive cash flow, which is always good, high rental yield can actually be bad. This is because rental yield is a function of both prices and rents, being the percentage return in annual rent on the purchase price of an investment property. Put simply, it means that rental yields will rise if prices have fallen, even if rents haven’t risen, or if rents have not fallen as much as prices. This is bad yield, and some of the highest rental yields put forward in various glossy promotions are in markets where prices have plummeted in recent years.

These “high yield” lists feature the usual suspects such as Broken Hill in New South Wales, Blackwater, Collinsville and Dysart in Queensland, Newman and South Hedland in Western Australia and Rosebery and Queenstown in Tasmania. They are shown in the table below, which also reveals how much prices have fallen in the last five years and even in some cases catastrophically crashed to create their current high rental yields.

As a result of these price falls, investors seeking positive cash flow might be tempted to buy in these towns because they have extremely low house prices. “Surely,” they think, “prices can’t fall any lower, and the rental yield looks extremely attractive”. If you are amongst them, remember that the high yield in these markets has nothing to do with rental demand and everything to do with falling prices.

MANY DWELLINGS IN SUCH TOWNS HAVE BEEN ABANDONED

The Bureau of Statistics tells us that these towns also have another feature in common, which is a much higher than usual percentage of empty dwellings, which I have shown in the last column of the table. In Australia, around eleven per cent of homes are vacant at any time because they are being renovated, developed, or awaiting new owners or tenants.

Higher proportions of unoccupied dwellings in any locality might be holiday homes, speculative investor owned properties or unrented and abandoned dwellings. The table shows us that these towns have high percentages of empty dwellings, but they are not holiday homes, they’re empty because populations in these towns have fallen, housing demand is decreasing and they are unrented or even abandoned. By checking the recent price and rent movements in any housing market you will quickly expose bad rental yield.

WHERE TO FIND GOOD YIELD

Good yield is driven by rent demand, not by price falls, so look for high rental yield in areas with high rental demand, such as tourist destinations, tertiary education precincts, infrastructure construction zones and locations favoured by overseas arrivals. All of these households create genuine rent demand. Some of the highest good yields can be found in coastal suburbs where prices have risen in recent years, such as those shown in the table below, but these are seasonal holiday locations, and the high yield is only obtained during the peak summer season. Watch out for such seasonal variation traps.

Permanent and semi-permanent rental areas such as ex-Housing Commission estates or the older affordable outer suburbs of our major cities provide consistently high yields with solid rental demand. These areas might seem unattractive to some, but they have strong rental appeal to others.

For example, Risdon Vale is an outer suburb of Hobart with a constantly high good rental yield and it’s also where Tasmania’s maximum security male prison is located. The high yield is caused by rental demand from the girlfriends, partners and wives of the prison inmates who live in Risdon Vale so that they can more easily make conjugal and family visits to the prison. You might not wish to live near a maximum security male prison, but the secret to Risdon Vale’s high rental yield is that many others do.

Sources:

CoreLogic published house price and rental yield data

QuickStats 2016, Australian Bureau of Statistics

Property Power Database, Property Predictions