The importance of analysing the yield of an investment property cannot be overstated. Yield is a strong predictor of future property price growth and in the right region can generate double the cash flow of that in the wrong region, as inSynergy’s Richard Sheppard discusses.
What is yield?
Gross yield is the amount of annual rent a property generates as a percentage of its current value. For example, if a million-dollar property is achieving $1,000 per week in rent – which is $52,000 annually and 5.2 per cent of one million – then that 5.2 per cent is its gross yield.
Net yield is the figure after deducting costs and expenses, such as rates, insurance, maintenance and management fees. However, depreciation tax benefits can improve the net yield.
Most of the time the average gross yield for an investment property is around four per cent, yet at the start of a property growth boom, the rental yield is usually approximately 4.5 to 5.5 per cent. After the boom, the gross yield is around 2.5 to 3.5 per cent, which is where Sydney is right now.
How depreciation impacts yield
In areas like Brisbane, which are just starting to boom in 2018, properties cost around 50 per cent of similar properties in Sydney. You can buy approximately two times as much property for one million dollars. That can mean buying two similar properties in Brisbane for the same cost as one in Sydney, or a four or five-bedroom house in Brisbane rather than a one or two-bedroom unit in Sydney.
If you can buy twice as much property in Brisbane compared to Sydney, you will also get twice the depreciation tax benefit.
Moreover, given that depreciation is a tax benefit, it is effectively money in your pocket, so more cash flow which serves to improve your net yield.
Running the numbers…to nearly 100% better!
If we compare a typical one million dollar property in Sydney, a two bedroom unit, and one in Brisbane, a four-bedroom house, the average rent in Sydney is about $600 per week, or $31,200 pa which represents a 3.1% gross yield. In Brisbane, it is about $900 per week, or $46,800 pa, which represents a 4.7% gross yield.
If we now add up the typical ongoing costs such as rates, insurance, maintenance and management fees, the total costs for the same one million dollar properties add up to about $250 per week, or $13,000 per annum each.
If we deduct this amount from the gross rent, for Sydney the $600 gross rent reduces to about $350 net per week, or $18,200 pa, which represents a 1.8% net yield.
If we deduct the $250 costs from the $900 gross rent for Brisbane, the net rent return reduces to about $650 per week, or $33,800 pa, which represents a 3.4% net yield.
In relative terms, 3.4% is 89% higher than 1.8%!
If we then add the substantially higher depreciation of the Brisbane four bedroom home to the Sydney two bedroom unit, the net yield of Brisbane is almost 100% higher!
Higher yields also help you buy and hold more property because the higher rent improves borrowing capacity and cash flow. However, as the forecast growth for Brisbane is much higher than Sydney for the next seven years, the difference in growth is compounded even further.
When BIS Shrapnel and Residex are forecasting around one per cent growth per annum for the next three and seven years for Sydney vs four – seven per cent per annum for Brisbane, the difference in total returns is looking to be extraordinary!
Over seven years, the difference between growth and yield by investing in $1m now is likely to be close to $1m more in Brisbane, but of course, with much stronger growth and yields in the first few years, you could comfortably invest in additional property. This could quickly turn the total difference into more than two million dollars of equity in just seven years!