What do you want from your rental property portfolio? Do you want short term cash flow from rental income, or do you want long term capital growth? Ideally, your portfolio needs both of these elements to truly perform in the market.
Rental yield: what’s it all about?
To put it simply, a property’s rental yield is the amount of rent which can be drawn from a property as a proportion of its value. Property features, overall space, proximity to local amenities and attractions, local crime and desirability indexes will all have an impact on the monthly rent a property investor can expect to receive. These are the same factors which affect its overall value.
So, what does this mean in real terms? Well, as of August 2016, average prices for rental properties in Auckland were around $500. Meanwhile, the average total value for a rental property in Auckland is currently around $956,000.
Weekly rent of $500 translates to $26,000 across the year. Dividing this figure by the total property value multiplied by 100 gives us a rental yield of 2.72%.
There are two things to bear in mind here, however:
- Average rent rates and properties prices are higher in Auckland than in other areas of New Zealand.
- Rental yields on New Zealand investment properties do not take into account other costs. These may include periods of vacancy, interest rates, or mandatory repairs.
Property capital growth: What’s that all about?
If your aim is to purchase an investment property in New Zealand with a view to making a serious profit on it in the future, you are probably looking at long term capital growth, rather than short term cash flow from rent.
While riding the market may give you a tidy profit when it comes to selling up, savvy investors aim to safeguard their return by developing the property and increasing its value. This means that – even if the property market takes a tumble – they stand a good chance of achieving a lucrative sale.
Read more: Understanding the property cycle
However, such a strategy is not free. In order to make a property more saleable in the future, a great deal of investment is required. Improvements, maintenance and other work will see the investor making a monthly loss on their property, even if they are able to rent it out at the same time. Over time, they should receive a major return, but it must be noted that this is a long term strategy.
Property capital growth: cheaper properties vs more expensive properties
Of course, it may not always be necessary to make major improvements. If the property is located in an increasingly sought after area, or if the local area is undergoing developments of its own, the investor is still likely to achieve significant capital growth over time.
However, even if the investor opts for this strategy and chooses to draw a rental income from it while the value grows, there are still costs involved. The property market has shown us that properties which are more expensive to begin with are the properties which experience the best returns after capital growth.
By comparison, cheaper, more affordable properties have a tendency to achieve only minimal capital gains. This means that, in order to secure a strong return on your investment property in NZ, you need to spend big and acquire a more expensive property. This leads to more debt on your home loan, potentially higher interest rates, and a greater capital expenditure to cover when you put down the deposit.
Top takeaway tips
- Unfortunately, you can’t achieve the best of both worlds on a single property, so strive for a balance between yield and capital gain.
- If possible, investors should look to diversify their property portfolios to include units which will provide high levels of cash flow performance in the short term, and more expensive properties which will provide big returns in the future.
- New builds generally have better yield but lower capital growth.
- Apartments generally have higher yields, but lower capital growth than houses.
- Properties with larger sections generally have greater property capital growth.
- The more expensive the property, generally the lower the yield.
- A property's yield generally contributes less than half of its value over time.
- To maximise your capital growth, try hold onto a property for at least 7 years.
- If a property seems like a high yield “get rich quick” scheme, then it will likely deliver low capital growth.
- Land, renovations, and improvements to a property and its surrounding area will likely fuel future capital growth.
- Don’t buy a property based solely on the best rental yields. Make sure you factor in capital growth for a well-rounded investment.
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