How to: Use the rental yield statistic
On Monday, we looked at how you can work out the rental yield for a property and the calculations behind the rental yield. If you haven't tried varying the rent and the price to see how it might affect the yield, it's worthwhile having a quick play with the equation.
However, what is the use for this statistic?
Comparison between properties and their return
There are a huge number of properties across the country, and when you're looking at those transacting at any one time it can still be overwhelming. When looking to buy, investors are going to need to be able to discern between the property that performs well and is likely to stack up, compared to the property that is not as profitable. While the rental yield is just one of a number of statistics to look at, and in isolation its usefulness is questionable, it's worth using this as one point to begin comparing the property.
You can also use it to compare the property against those you already own - to see how the return may look if you sold one property and bought another, or to ensure yours is not underperforming, which may be a suggestion that there is something not-quite-right about your numbers, such as your rent being set below market value.
For "yield chasing" investors - those that look for as high rental yields as possible - comparing this statistic is part of their hunt for the best property. If looking for cash flow, it's just the tip of the iceberg, with the next step being to look at potential repairs, vacancies, levies, rates and other costs that will erode this income.
Shortlisting and benchmarking
Ensuring your property is performing, as mentioned above, is an important aspect to look at. One way to do this is to look at the average and median statistics available for suburbs, particularly those where the properties tend to be homogenous. While the use of median statistics is hotly debated, it's an extremely quick way to cross check a figure and to ask yourself important questions as to why your rental yield is or isn't as good. You can check these statistics via our free suburb data.
You might also have certain points in your mind about what it takes for a property to fit into your portfolio and the numbers you need to achieve. The rental yield can create a part of this picture. There are many investors who require a property to have a number of aspects for them to even consider (such as Jane Slack-Smith's Trident Strategy), and it is one way that you can take on the mammoth task of deciding where to invest and which properties suit.
As a market indicator and quick alert
Not as commonly used, but still of great benefit, is the role of the rental yield as a market indicator. Keeping an eye on how the area's median fluctuates can quickly get you asking important questions that may allow you to deduce a little more about the suburb. For instance, if the yield is increasing it doesn't necessarily mean that rents are rising - perhaps property prices are dropping? Perhaps there has been a brand new development finalised and rented for the top dollar?
Instead of having to look at a number of different indicators, the rental yield will quickly have you crossing off different reasons. It can also be worth using your understanding of the rental yield to question when someone tells you that an increasing yield in an area is a good thing. Are they using this to cover up a drop in prices? Or is a soaring rental yield suggestive that capital gains are to follow? Looking at historical information around this statistic can also give you a different insight into the area you are considering.
As an identifier of risk
Mining towns and regional areas have higher-than-the-usual rental yields in common. Moranbah, for instance, saw yields of 20% at one point. Now our median statistics point us to a 7.4% and a -42.5% median price change over the last year. The Top Ten rental locations from RP Data were all within regional mining town precincts. Similarly, the US can also have very attractive rental yields due to their comparatively low prices - we've seen examples of around 16% rental yields.
High returns and high risk often go hand in hand, and an area or property boasting a very high rental yield should have you asking two things:
1) What is the catch?
2) If there isn't one, then why hasn't anyone else bought it yet?
If you can't satisfy these questions, then you'll want to keep on digging for answers.