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What is a good rental yield for property investors in Australia?

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What is a good rental yield for property investors in Australia?

In the world of property investment, knowledge truly is power. It’s not just about finding a property; it’s about understanding how that property can work for you, and that’s where the concept of rental yield comes into play. Whether you’re a seasoned investor or a newcomer to the game, understanding rental yield and its implications can make all the difference in your investment strategy.

What is Rental Yield?

Rental yield is essentially the return on investment that a property generates through rental income. It’s a percentage that indicates how much money you’re making from your property relative to its value. In simpler terms, it’s a measure of how efficiently your property is putting money in your pocket.

How to Calculate Rental Yield

Calculating rental yield is straightforward. You take the annual rental income of the property and divide it by the property’s value, then multiply by 100 to get the percentage. The formula looks like this:

gross-rental-yield-formula

Cities with the Best and Worst Rental Yields

Location, as they say, is everything in real estate. Some of the top-performing suburbs for rental yield can be found in regional areas and smaller cities due to lower property prices and strong rental demand. Major capital cities like Sydney and Melbourne offer lower rental yields due to their higher property prices despite promising capital growth prospects.

In Australia, the rental yield landscape varies from city to city. According to CoreLogic’s 2023 Q3 Rental Review, Darwin emerges as the highest-yielding capital city for houses, boasting an average gross rental yield of 6.02%. Conversely, Sydney and Melbourne lag at the bottom, offering 2.60% and 2.95% average yields respectively.

Why Rental Yield Matters in Your Investment Strategy

Rental yield is a key indicator of your investment’s profitability. A higher rental yield means more money in your pocket each month, which can translate to better cash flow and a healthier bottom line. It also provides insight into the overall health of the property market and can help you make informed decisions about where to invest your money.

Understanding the Relationship Between Rental Yield and Property Price

There’s an inverse relationship between rental yield and property price. As property prices go up, rental yields tend to go down. This is particularly evident in major capital cities where property prices can be sky-high. While investing in these cities may offer potential for capital growth, the lower rental yields may not be as attractive for investors focused on cash flow.

Let’s consider two scenarios to illustrate the impact of property price and rental income on rental yield:

Scenario 1: 

You own an investment property with a weekly rent of $400, and the property is tenanted for the entire year. The purchase price of the property is $400,000.

Your rental yield = (400 x 52/400,000) x 100 = (28,000/400,000) x 100 = 5.2%

In this scenario, the rental yield stands at 5.2%, which is considered a very good rental yield.

Scenario 2:

Now, let’s consider a different property with a higher purchase price and rent. The property is priced at $1.2 million, and the weekly rent is $700.

Your rental yield= (700×52/1,200,000) x 100 = (36,400/1,200,000) x 100 = 3% 

In this scenario, despite the higher weekly rent, the rental yield drops to 3%. This low rental yield indicates that the property may not generate sufficient income to cover expenses, potentially resulting in a negative cash flow situation.

Why Avoid Properties with Rental Yields Below 4%

As a rule of thumb, many investors steer clear of properties with rental yields below 4%. While this threshold isn’t set in stone, it serves as a benchmark for assessing the viability of an investment. Properties with low rental yields may struggle to generate sufficient income to cover expenses, leading to negative cash flow and diminished returns.

Taking Expenses into Account

It’s essential to factor in expenses like mortgage fees, property management fees, and maintenance costs when calculating rental yield. By accounting for all expenses, you can ensure that your rental income adequately covers your outlays and protects against negative cash flow.

Considering life’s uncertainties, such as job loss or unexpected family events, relying on an investment property with a low rental yield could pose financial challenges. It’s essential to carefully assess the balance between rental income and property price to ensure your investment property remains financially viable and continues to provide passive income.

Considering Rental Yield and Interest Rates

Interest rates play a significant role in shaping rental yield dynamics. When interest rates are low, borrowing costs are reduced, which can drive up property prices. However, this can also lead to compressed rental yields as property prices outpace rental income growth. On the flip side, rising interest rates may lead to lower property prices and potentially higher rental yields. In a high interest rate environment, however, landlords may seek to increase rents in response, there is a ceiling dictated by the financial constraints faced by renters, particularly those on lower incomes. The ability of landlords to increase rents is limited by the affordability constraints faced by renters. 

Outlook for Rental Yield in 2024

Looking ahead, the outlook for rental yield in 2024 is influenced by various factors, including interest rate movements and economic conditions. With predictions of declining interest rates, investors may find themselves in a favorable position to capitalise on potential opportunities in the rental market. However, it’s essential to stay informed and adapt your investment strategy accordingly.

In conclusion, rental yield is a critical metric for property investors in Australia. Investors must carefully assess the rental yield potential of properties in different locations to ensure they achieve their desired returns. Factors such as property value, rental demand, and rental income and property expenses should be considered when evaluating investment opportunities. And remember, when in doubt, seek guidance from professionals like PropHero to ensure you’re making the smartest investment choices possible.

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