Property investing 2024 – It’s all about the yield

WITH GARETH KENT, DIRECTOR AT PRESTON ROWE PATERSON

The property year has begun and as always you will start seeing lots of economists and gurus making forecasts in the next few weeks, as they do every year, but before I make any myself I must stress that there is a profound difference between a forecast and an expectation.

An expectation is looking to past trends, a forecast is putting a timeframe to those trends and applying it to the present. In an ideal world that would be logical, yet we don’t live in an ideal world and it is continually illogical. We cannot see the future, there are just too many moving parts and sometimes things happen that have never happened before. So make your investment decisions cautiously optimistic, back yourself, but keep some powder dry for the unexpected downturn, with the knowledge that it will come.

Being intimately involved in the market, I can see some indicators to assist in knowing where we are in the property cycle.

This weekend will be the third ”auction weekend” and I am very happy to note that auction clearance rates have come back strongly with an average of 72 per cent across the state. This is a stronger level than the last five months of 2023, meaning confidence has slightly recovered from successive interest rate rises. In support of this, ‘PEXA’ has reported that settlement numbers have increased, despite low listing numbers. Retail spending is up, the unemployment rate is still at 3.9 per cent, and inflation around the world seems to have peaked and is now declining, although the RBA is still seeking further decline to get it back within its target range.

However there is evidence of stress in the market, large volumes of homeowners have come off their fixed rates, and for the past 6-12 months, they have absorbed the increase. In the last few weeks, I have observed many ‘stressed” sales, not in liquidation, just properties that have sold for less or similar amounts than what they were purchased for, both commercial and residential, factoring in stamp duties.

Some sectors of the market, such as commercial industrial sheds, that have experienced a bull run, are now in an oversupply situation, with high volumes of vacancy and declining rentals. Likewise, several retails have been transacted with no increase in value for at least the past three years. Residential rentals are also hit-and-miss, although there is a well-publicised housing shortage, residential rental increases have slowed.

So have we passed the danger point and are we at the bottom of the new cycle? I think so. If you were clever enough to have a war chest, in my view, it’s time to start buying, with an emphasis on properties that can provide positive yield, and an expectation that this cycle will be elongated, meaning that capital growth will be a slow burn.

Hence, we look to the indicators of yield. A property rental yield is the amount of gross rental income relative to its market value. In the Geelong, Bellarine and Surf Coast regions our residential yields typically fall between 3.5-7 per cent annually, however, some properties reach 8.5 per cent and higher.

Several factors influence rental yield, in my view the biggest driver of rental yield is location. The location reflects the balance between demand and supply. For example: Geelong West and Newtown have higher rentals, as demand to be in those inner city locations is higher, however, they also have higher market values, and the yields in those locations are toward the lower end of the range typically about 4.5 per cent or lower.

Another factor is the condition of the property. A new property, typically is highly sought after, has less upkeep and maintenance and has some tax depreciation benefits. When compared to older properties, new properties attract a higher overall yield. Another factor to consider, especially so with commercial, is that a property’s yield can reflect its composition in terms of building and land values. When a property boasts a higher yield, it often reflects a substantial building value percentage over the land value. A low-yielding property can reflect the potential for development or a higher percentage of land value to building value.

In regional areas, we typically have much higher yields than within the cities, and this is mostly due to the lower expectation of capital growth and market value of the land. Statistics have shown that for a property with a gross rental return of 7 per cent or higher, the chances of exceeding 4 per cent in capital growth are very slim. In short, higher investment yields can be a sign that capital growth is unlikely, and hence they may not be good investment areas.

However, for the more savvy investors, there are a few tricks you can use to attract a substantial positively geared yield while still attracting capital growth. And that is the potential for alternative use, either by a planning change or a structural change to the property. This is not for the faint-hearted or uninvolved investor, the risk is much higher and the ongoing management fees and associated costs can exceed what you had initially intended, and the net yield will be impacted.

Rental yield is a valuable tool in assessing the investment potential of property.

Lastly, I’m often asked about negatively geared property; in other words, investing in property that is losing money. I do not and never have prescribed to this theory, it’s just bad business. Negative gearing also relies on your ability to absorb the additional cash costs and assumes your capital growth will be strong enough in the long term to make it worth it. Negative gearing puts all your eggs in one basket, by relying on your income to cover the shortfall, and cash is king!

I stress we are at the bottom of a new elongated property cycle, and capital growth potential in the next few years is limited. Hence. investors should be looking for strong-yielding property that can cover their own costs.

Yes, it’s time to get back in on the market, but do your homework; yield can be a very formidable tool to help guide your decisions.

Happy February, everyone.