In real estate investment, many people measure their returns based on gross rental yield. But what exactly is rental yield and how does it work?
Here we discuss the concept of chasing property rental yield and explore the associated risks and benefits.
What is rental yield in real estate?
The concept of yield in real estate investment refers to the annual rental return a property achieves, typically expressed as a percentage.
It is usually measured as the annual rental income divided by the property’s purchase price or value.
A high yield means that the property generates a higher return on investment compared to properties with a lower yield.
Chasing high yield in a residential investment property can be an attractive strategy for investors, but it also has its disadvantages.
What are the disadvantages of chasing high yield property?
May be located in less desirable locations
One of the main disadvantages in chasing high yield is that properties that generate high rental income may be located in less desirable areas.
These high rental yield suburbs may have higher crime rates, lower performing schools, or other negative characteristics that make them less attractive to tenants.
As a result, it can be more difficult to find tenants for these properties and keep them occupied, which can lead to increased vacancy rates and lower overall returns.
Higher risk of low-quality properties with maintenance costs
Another disadvantage of chasing high rental yield is that properties that generate high rental income may be older and require more maintenance and repairs.
Such properties may have outdated systems and appliances, worn-out roofs, and other issues that need to be addressed. This can eat into profits and increase the overall cost of ownership.
On the flip side, they could also be brand new homes located in the ‘mortgage belt’ of capital cities. These newly finished homes are often still in a depreciation phase while the land content that is responsible for the capital growth, is often much smaller. Family blocks are often considered 450sqm or below in many new estates.
Over-leveraging
Over-leveraging is another disadvantage of chasing high yield real estate. Buying a property with a high rental yield may require taking on a large amount of debt, which can increase the risk of default if rental income does not cover mortgage payments.
This is particularly risky for investors who do not have a significant cash reserve and rely heavily on rental income to cover mortgage payments.
Certain regional centres often offer strong rental yields, but are more speculative in terms of upswings and downswings in value. If you are caught in a downswing since purchase, you can often be left with an asset financed higher than the actual value of the property.
What are the advantages of chasing high yield property?
Despite the drawbacks, there are also some advantages of chasing a high yield in a residential investment property.
Higher return on investment
One of the key advantages is that high yield properties can generate a higher return on investment compared to properties with a lower yield.
This can be particularly appealing for investors who are looking for a way to maximise their income returns. Additionally, properties with high yields can generate a steady stream of income that can be used to cover other investment expenses or to fund other investments.
Inflation hedge
High yield properties can also provide a hedge against inflation. When property values are increasing and interest rates are low, investors can benefit from the increased cash flow and appreciation of the property value.
Additionally, in a rising interest rate environment, the high rental yield can offset the negative impact of the growing interest rates on the return on investment.
More affordable for small investors
Additionally, high yield properties may be more affordable for investors who do not have a large amount of cash or credit available. Because these properties typically generate a high return on investment, they can provide a good return even with a relatively small investment.
Is a high rental yield investment right for you?
It is our opinion that high yield properties aren’t suitable for everyone; they are only suited to certain types of investors.
For example, an investor who is comfortable taking on higher risk and can tolerate the extra volatility associated with high yield properties may favour this type of investment.
On the other hand, an investor who is more risk-adverse may not wish to include this type of property in their investment strategy.
As Jack Dunkeld, our Research Analyst often states: “In property, yield is often a reflection of risk”.
Therefore, before making a decision on chasing high yield, it’s essential for investors to carefully evaluate the potential risks and rewards. You must also consider your own investment goals, risk tolerance, and financial position.
Additionally, it is important to look at the long-term outlook of the market and the area – and not just the yield. Consider factors such as the local economy, job market, and potential for future development.
With proper due diligence, investors can make a more informed decision and determine whether chasing high rental yield is a viable strategy for them.
At Momentum Wealth, we often assist our investors to increase yields on their properties that are well located for growth and in areas that have strong track record growth. Many of our clients seek out a blend of both capital appreciation and yield, with potential to add value to the property over time.
For more information on property yields, please contact us today. Our specialist team can provide guidance and expert insights – whether you’re just getting started in property investment, or you’re a more experienced investor wanting to review your property investment strategy.
