Last week I talked about how investors will accept a lower yield. You can read last week’s article here and should do so before reading this one.
Today I wanted to discuss how house prices will increase because rentals yields are increasing.
What I am saying is that we are seeing rent prices go up, therefore we will see house prices go up too. Even though rental prices have nothing to do with owner occupied property or people who currently own a home, they are a temperature indication of the market relating to supply and demand.
In one of our seminars last year (when we could have groups of people gather), I talked about the relationship between supply and price, not necessarily the relationship between supply and demand. Rental yields reflect the relationship between supply and price.
I am sure we can all remember a time when house prices and rents were cheaper.
I’m not going to get into semantics here of cheaper, meaning dollars spent in relation to dollars earned, or the application of the word ‘value’; let’s just agree that in previous times, house prices and rental prices were offered at lower dollar values.
The relationship between rental yields and price is all based around acceptable long-term averages. In last week’s scribbles, I showed you how investors will actually end up accepting a lower yield rate because the cost of debt is substantially lower than in previous years.
In that article I demonstrated how a long term yield average of say 5% in a suburb in southeast QLD dropping to a 4% yield, from a change in rent or a change in house price, would make investors substantially better off due to the low cost of debt.
Let’s take that example
of a property in southeast Queensland, with a long-term average rental yield of 5.2%, meaning a $600,000 property rents for approx. $600 per week. If the rental price increases after you have purchased the home, as the landlord your rental yield goes up. Over time, if that rental price increases to $660.00 a week, the rental yield increases due to being pegged to your $600,000 purchase price. Then new rental return (gross yield) to you, is 5.7%.
It is fair to assume that if you wanted to sell this property it would probably have increased in value due to the market activities, but not solely because it has increased in rental price. Rental prices are a good indicator, but unlike commercial property, residential property is not directly connected to its rental price. Rental prices are often a result of higher prices not the cause of them.
But if we did work backwards, you could begin to calculate what price value your property may have due to the market activity in your area with rental prices being one indicator of that. If you chose to sell your property, based on the same 5% yield that was being returned when you bought the property, you would now be listing it for sale at $660,000.
With those basic relationships highlighted let us have a look at what happens when investors accept a lower rental.
Same situation, a $600,000 property that rents for $600 per week. However, in this scenario the rent prices do not increase but the accepted yield rate does.
If the market is hot…
and investors want to buy in this area, and for some reason, rents stay stable then as I discussed last week, investors can afford to accept a lower rental yield because the cost of debt is so low.
The calculation looks like this: the accepted rate of yield drops to 4.5% but the rental figure hasn’t changed, meaning the investor is now buying the same property ($600 per week rent) for a price of $693,000.
These two examples are highlighted to show a point, but it is very easy to see how you could blend the situations when rents increase slightly and investors accept a lower yield, you will see a massive uplift in home prices.
Perhaps something like this:
As you can see, both the long term accepted yield rate and the rental price can play a role in the market price of a property.
Do I think investors are solely responsible for driving up prices, NO.
Do I think owners are responsible for driving up prices, perhaps, but not solely?
Investors jump into a market when returns increase and jump out again when returns drop below comfort levels.
Rent Occupiers are happy when it is cheaper to rent than to buy, but get uncomfortable when it becomes cheaper to buy than to rent.
And that is what we have been seeing for the past 12 months, a large transition from renting to owning.
The market activities are all based on comfort levels.
Pretty funny hey!?
Since 2004 Scotty North has been helping people buy the best properties for their needs at prices that simply speak for themselves.
Scott has been instrumental in bridging the gap between financial planning and traditional real estate transactions through his property advice model.
Scotty North is a Qualified Property Investment Advisor (QPIA), with accreditations in financial planning, mortgage broking and real estate.
By carefully considering his clients’ goals and planning for market changes via demographics and trends, Scott designs a future proof outcome not only specific to the client’s needs but dynamic in its execution with performance indicators and exit strategies built in.
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