All major cities have experienced sharp increases in gross rental yields as prices have fallen over the past 12 months, according to separate analysis by investment bank Morgan Stanley.
Rental yields show how much cash a property is generating, or the rental income as a percentage of the asset’s value. The national average for apartments has increased to about 4.4 per cent and about 3.6 per cent for houses since the property price peak in September 2017, the bank’s analysis shows.
According to Paul Moran, principal financial planner with Moran Howlett Financial Planning, an investor attracted by the prospect of a high-yielding property investment to boost income needs to understand the difference between gross and net yield.
The returns offered by real estate agents are typically gross yields and are easily calculated. “But it is very important to look at net rather than gross yields as this can materially reduce the yield,” Moran says.
An investor needs to take into account ongoing expenses and potential income changes including rent, vacancy rates, repairs and maintenance, insurance, management fees and property value. A prudent investor will also add in depreciation, land tax, stamp duties, rates and mortgage insurance.
Total costs, plus the hassle of having to manage a property, could knock hundreds of basis points off the total return, making net yield less attractive and increasing the competitiveness of alternatives.
The CoreLogic analysis cites median prices. “Buying at the median price has always been a smart option for savvy owner-occupiers and investors,” according to Shaun Thomas, residential director of Herron Todd White, one of the nation’s largest property valuation and advisory companies.
“You’re not buying the worst property in the suburb and you’re not buying the most expensive,” Thomas says. “This helps reduce the impact if the market does shift.”
The top gross yielding suburb in Sydney, offering 5.1 per cent, is Lakemba, which is about 16 kilometres south-west of the central business district. Median Lakemba apartment prices are about $390,000, or more than 80 per cent less than for the city’s overall median, according to Herron Todd White.
A lot of suburbs offering high yields, particularly for apartments,are in areas of high student accommodation, such as Carlton and Notting Hill near Monash University’s Clayton campus in the south-east suburbs of Melbourne.Student apartmentsclustered around major universities and colleges are generating about 6 or 7 per cent, CoreLogic analysis shows.
Student apartments are popular with cashed-up self managed superannuation fund (SMSF) investors and retirees looking for yield. “Typically, these are high yield but have experienced virtually no capital growth due to lack of demand over the past five years,” Moran says.
In some cases, oversupply and slow demand has contributed to prices falling. Nervous lenders are shunning investors seeking financing for purpose-built student apartments as values fall, according to industry specialists.
“Investors also need to be very aware of a yield trap, where yields are high because prices have fallen significantly,” Moran says.
“This often occurs where a structural change occurs, such as a mining town downgrade, or a significant employer closes.”
For example, hundreds of investors sold high-yielding property in one-time mining hotspots, particularly around Perth and Darwin, were left high and dry after the boom times ended. These postcodes were not included in the survey but typically top most surveys.
“In this case, both the rents and property prices will fall eventually due to a lack of demand,” Moran says.
Tax specialists are warning a similar rush could happen if there is a change of federal government at this year’s election, as fears that lucrative negative gearing tax concessions might be lost causes many investors to head into the market.
The number of households with multiple investment properties has grown strongly in recent months, despite overall market conditions sharply deteriorating, according to Morgan Stanley. There has been a 4 per cent increase in the number of investors with four, six or more properties, its analysis reveals.
At present, investment property income is taxable and the costs of the property, such as mortgage interest, rates, cleaning, estate agent fees and body corporate fees are tax deductible. Any losses where expenses exceed income can be offset against other taxable income in the year. Provided the property has been held for more than 12 months, the 50 per cent capital gains tax deduction is available.
Labor is planning to reform negative gearing and the capital tax discount for new purchases effective from a yet-to-be-determined date after the next election, should it win.