When Chasing Rental Yield Backfires

If you know commercial property, you will know that the price is pegged to the rental return of the property.Angry 3

If your rent goes up, your property value goes up, and the opposite is true also. That is why most commercial property is left untenanted rather than renting it at a lower price. If the owner took a lower price, the bank can review the rental amount and therefore the property value, and call in the difference they deem necessary to bring the loan back to the original loan to value ratio.

In real terms this is not how the residential property market works on an individual property basis; more on an overall market basis (I will flesh that out in another article).
However there are some exceptions, like mining towns.

The most recent rise of mining towns can be traced back to the early 2000’s. The mining boom was on and more people were needed in these areas than ever before. Accommodation was in short supply and companies needed to house their staff so they paid top dollar to do so.

As such the returns increased to the point where even very low risk investors were buying, “Cause it was just so good!”
Blinded by greed?

The ability to own a house and rent it for a crazy sum of money was a license to print money. However the market always finds a balance for risk vs return and that balance was around 10%.
Most high risk mining towns sat around the 10% yield. Most normal residential properties sit around 5%. In simple terms if a property cost $450,000 and rents at $450 per week, that is close enough to a 5% return.

If a property costs $450,000 and rents at $900 per week, that is a 10% rental yield.
Take Blackwater in QLD. It was very easy to price property in this town. If it rented at $850 per week then the purchase price will be $425,000. If it was $1100 per week then it attracted a $550,000 asking price.

These are great returns for residential investment property, and very appealing I am sure.
However there is a problem pegging your purchase price to rental return. If you buy one of the above mentioned properties, and the rent increases you have scored and your property goes up in value.

However, if the rent goes down, your property value will plummet too. Just like commercial property.
This is what has happened in mining towns. The rents have dropped and due to the risk the market still is only comfortable to pay a 10% rental yield. So whatever the new rent is, then the house price will be adjusted to suit.

In 2015 that adjustment happened.

When you look for an investment property make sure you don’t forsake good fundamentals to get great rental yield. Doing so means your portfolio is weighted towards risk and will by nature, be unstable.

Instead when you have an IDEA to buy a property make sure you FIND the right one. This is something we will cover in the next couple of articles.
Happy Investing.Scott Northcott Australian Property Advisor

Since 2004 Scott Northcott 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.  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.