Low rental yields & negative gearing freaks out investors

rentals

Intending investors are, in our experience, concerned with Capital Growth as their number 1 priority (naturally enough). Making capital gains, could be argued, is perhaps the ONLY reason to invest. No-one in their right mind buys property to get positive cash flow of $20pw. If that is what you want, there are easier options than investing in real estate with its high costs of entry and exit.

In 2nd place is Rental Yield, with most investors happy for neutrally geared (or slightly negative or positive). Rent being a key component in helping hold the investment for a period of time long enough for capital growth to do its work.

So in this part of the cycle, why are some investors freaked out by low rental yields of around 3.5% in many places, when it used to be around 5% or better? The answer is that rents are always the last to catch up after a property boom. You see property prices can literally go up overnight but rents are locked in on 6-12 month leases, so they lag behind property prices. This is perfectly normal. Traditionally what happens is that properties are purchased and are negatively geared, but over time, price growth takes a breather, rents creep up and rental yields return to trend. Then rental yields overshoot (to say 6% or better), investors move back in to buy for yield pushing property prices up……………….and so the cycle continues.

The key is to hold property for the long term. Ask any investor who has held property for 10-15 or more years. They will likely tell you that they purchased negatively geared property in good locations. Values over that time have often more than doubled. Mortgage interest rates have stayed almost the same within a band, meaning loan repayments are fairly steady, and their LVR’s have dropped from 80% at purchase time to nearer 40% now.  The good news on rents is that over this time, they have probably doubled as well, making the property positively geared. Investors see this as an ideal time to draw down a deposit from the increased equity in the property and repeat the process for wealth creation.

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