Rental yield is the annual rent from a property expressed as a percentage of its value.

So if a property costing $400,000 to buy earns $385 per week rent, that’s $20,000 per year or 5% of the investment: a 5% gross yield.

That gross bit is important because these figures don’t take into account ongoing costs.

Yields vary greatly from place to place and property to property, but generally speaking, metropolitan residential property typically yields around 4% to 6% (gross).

At some time or another all of us think about investing directly in residential property (even if we can’t afford it :). Here’s a quick overview to help you decide if property investment is something you should seriously consider.

Why do so many Australians buy investment properties?

1. The comfort factor. Property offers a ‘bricks and mortar’ tangible asset that many investors find more comfortable than shares. The risks associated with property are also ‘closer to home’ and easier to understand for many people than the complexities and lack of transparency of big corporations.

2. Investment Returns. Long-term returns from property have historically been neck and neck with the stock market. One study going back to 1926 indicates returns average just over 11% per annum for both these asset classes – much higher than cash or fixed interest alternatives. These returns come from both rising rents and capital appreciation and ultimately stem from economic growth, immigration and shortages in supply.

3. Tax effectiveness. ‘Negative gearing’ simply means that if a property investment makes losses after paying loan interest and other costs, the loss can be deducted from other income and so reduce income tax. For those paying high marginal tax rates, this is often perceived as very attractive (for some, even more so than franked dividends from share investing). In addition, only 50% of profits from sales of investment properties held for more than 12 months are taxed (as is true of shares held longer than 12 months: see Share investing – Dividends and Tax Credits).

4. ‘Forced’ savings. As most people lock themselves in to long-term loans to fund their property investments, the mortgage repayments effectively become ‘forced savings’, providing a savings discipline that is difficult to match.

But what about the risks?

1. Size matters. Unlike many other forms of investment, property is ‘chunky’. You can start investing in shares with a few thousand dollars… or even with a few hundred. With average metropolitan dwellings costing upwards of $400,000 property investors need more like $40,000 to $80,000 to fund the initial deposit and other costs.

2. The risk of capital loss. Property is usually perceived as less risky than shares, and measured price volatility bears this out, but in part that’s because home prices aren’t really valued on a daily basis.

Prices can and do fall, however, particularly within sections of the market. At different times, market niches – from inner city Sydney apartments to Gold Coast holiday properties – have had their turns at price falls of 15%, 20%, even 25%.

As many investment properties are funded largely with debt (which of course does not fall in value) and as the amounts are usually large, these falls can cause a great deal of financial distress.

3. Liquidity and transaction costs. If you need access to your money, you can sell your share investments quickly, easily, and without much cost. Not so with property. Property investors face months to sell at other than ‘fire sale’ prices and have to consider advertising costs, selling agents fees, legals and loan break costs.

4. Cash flow shortfalls. In addition to predictable costs (like maintenance and repairs, building and landlord insurance, land tax, water rates, council rates, etc) unexpected cash flow shortfalls can play havoc with family finances. These can come from:

  • interest rate rises
  • vacant periods – prepare to pay the full mortgage yourself when tenants move out and replacements have not yet been found
  • unexpected property repairs.

5. Bad tenants. Most tenants take reasonable care of the properties and pay their rent (pretty much) on time. Bad tenants can damage the property, refuse to make payments and sometimes even refuse to leave the property. Disputes can take months to resolve and become costly and stressful.

Still interested in investing in property? Have a look at ‘Make your property investment a success – start by getting the strategy right‘.

What are your thoughts?

Do you own an investment property, or are you thinking of buying one? Is there more you’d like to know about property investment? Join the conversation — leave a comment below and let us know what you’re thoughts are.

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