Investors may dream of buying a cheap property with high rental yields that soars in value while providing a steady stream of rental income, but new research shows the opposite is usually true.
A five-year analysis of Australia’s housing market found that high rental yields (the amount of rent a property delivers in a year expressed as a percentage of the home’s purchase price) don’t necessarily lead to high overall returns for investors.
Properties in affordable areas delivered higher rental yields, putting more money in a landlord’s pocket in the short term, but delivered lower overall returns (calculated as capital growth – the amount a property increases in value over time – plus rental return) in the medium to longer term.
This is because home values in cheaper areas took longer to significantly rise in value.
Conversely, properties in expensive areas offered lower rental returns, but delivered much higher overall returns over time, the report by RiskWise Property Research showed.
The analysis tested the performance of the top 100 and bottom 100 rental return suburbs in Australia over a five-year period from 2013 to 2015.
Under the assumption of a 20 per cent deposit, the analysis showed low-rent houses would increase their net equity by 63.1 per cent while high-return houses would increase their net equity by only 29.5 per cent.
“This means low-rent houses increased their equity by more than twice that of the high-rent ones,” RiskWise chief executive Doron Peleg said.
The best performing low-rental-yield properties were located in pricey suburbs such as Sydney’s Rossmore where the median house price is $2.2 million, and Melbourne’s Malvern East where the median house price is $1.55 million. They experienced overall returns of 176.1 per cent and 124.2 per cent respectively over the five years to 2018.
“When you break down properties with high rental returns and low rental returns, you see purchasing the high rental returns is extremely affordable, whereas a low-rental-return dwelling costs roughly three times more, which generally means they are blue chip,” Mr Peleg said.
“What it means is people who invested in very affordable suburbs that carried a high level of rental return, with the expectation to see strong overall growth, have achieved exactly the opposite result.
“Most people think they will see high overall return (that includes at least a reasonable capital growth) if they have high rental returns, but our data clearly shows this is not the case.”
Last year, research by leading property analysts Propertyology revealed a handful of suburbs around the nation that were proving cashflow positive for landlords almost immediately due to a combination of low home prices and high rental returns.
However, as the RiskWise research shows, while investment properties in such areas can “pretty much pay for themselves”, the catch is that investors may be waiting a long time before their property rises in value and their investment really pays off.
No suburb listed in the top 100 housing rental returns also made it on to the list for top 100 capital median growth over the past five years, Mr Peleg said.
“In fact, 22 per cent of those listed in the top 100 suburbs for housing rental yield were in the lowest performing 100 for growth,” he said.
Some suburbs with high rental returns even saw home values falling as the housing market weakened, analysis showed.