July 13, 2024

Vagmare.com

The Intersection of Information and Insight

What does the rental yield tell you about a property?

5 min read

A property’s rental yield is the amount of gross rental income that it attracts relative to its market value.

In Australia, gross residential property rental yields typically fall between 2% and 5% annually.

This yield can provide insights into a property’s fundamentals and therefore anticipated investment returns.

What drives a property’s rental yield?

Two primary factors influence a property’s rental yield.

Firstly, the size and condition of the property have the largest influence on rental income.

Larger properties with more bedrooms and living areas generally command higher rental incomes.

A new property often fetches a premium rental, while a poorly maintained one tends to yield below-average income.

Additionally, amenities like a pool can amplify rental potential, especially in warmer climates.

The more a landlord has to offer, the more rent they can command.

Secondly, a property’s location plays a pivotal role in determining rental income. Location dictates the balance between rental supply and demand.

Highly sought-after areas, such as prime spots in blue-chip suburbs, attract higher rents due to demand outstripping supply.

Coastal locales often experience a shortage of permanent rental properties, as many owners prefer short-term arrangements (e.g., Airbnb), leading to higher yields for permanent rentals.

Similarly, properties in regional locations and small towns can generate high rental yields due to a lack of available rental properties.

Furthermore, a property’s expense profile can impact rental yields. For instance, apartments with high body corporate fees often translate to higher rents to offset these expenses.

Of course, higher body corporate fees often mean the property offers a lot of amenities.

In essence, a property’s rental yield is mostly shaped by its physical attributes and location.

Possible explanation # 1: Proportion of land and building value

A property’s rental yield often reflects its composition in terms of building and land values.

When a property boasts a high yield, it often indicates a substantial building value, constituting more than 50% of the total value.

Conversely, a lower yield suggests that the property’s value predominantly lies in its land.

This pattern emerges because renters generally pay for better or larger accommodations rather than the underlying land value.

Typically, rental market preferences lean towards low-maintenance properties, ones that require minimal upkeep, such as limited garden space.

Hence, the allure for renters revolves more around the quality and size of the living space rather than the land itself.

Capital Growth

Possible explanation # 2: Low expected capital growth

In regional areas or small towns, properties often yield higher rental returns due to a scarcity of available rentals.

However, these locations have abundant land supply and lower demand due to low population, causing slower land value appreciation compared to capital cities.

Consequently, investors may enjoy elevated rental yields but experience slower growth in property value.

Looking at past returns, it’s improbable for an investment-grade property to yield a total gross return of more than 10% p.a. in the long term.

If a property’s gross rental return sits at 6% p.a. and isn’t anticipated to change, the chances of capital growth exceeding 4% p.a. are very slim.

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