Landlords should be focusing on higher yields

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Over the next few years, capital gains will be harder to come by for property investors, which means the “nuts and bolts” of being a landlord are likely to become more important.

Monday, June 13th 2022, 10:40AM 1 Comment

by Sally Lindsay

These include a focus on cost control, rents increases, and, most importantly, buying properties with the highest yields - for the lowest risk.

Some of the key drivers of returns in recent years, for example, strong capital gains and positive monthly cashflow, especially over 2020-21, have been dramatically reduced, and the economics of investment look likely to be trickier over the next few years.

Average property values are now falling steadily, and if the 2008-09 financial crisis is anything to go by, even after the market has reached the bottom, it could be a number of years until it regains the recent house price peak. In other words, the next four to five years could be a quiet time for capital gains.

In its latest Market Pulse, CoreLogic’s chief property economist Kelvin Davidson says in this environment, it will be no surprise to see investors focusing on yield - trying to buy properties that have the highest rent in relation to their purchase price, albeit still within the investor’s tolerance for risk.

So, where can landlords find yields and property types which are the most appealing?

The national average gross property yield is now just 2.6%, versus the average standard two-year fixed mortgage rate of 5.6%.

The negative yield gap of -3% is the biggest since mid-2010, or in other words the least favourable position for property yields versus mortgage costs for more than a decade, after a period in 2020-21 when it was beneficial for investors.

It’s also worth noting term deposit rates for durations of at least a year are now generally back at 3% or more, and flows of money into term deposits have started to pick up again after previous outflows.

Davidson has drilled down to property type and location.

Starting with apartments - and a minimum threshold for number of properties - Davidson says for a fairly typical two-bedroom property there are still a few areas with gross yields of at least 4.5% – such as Auckland’s Newton/Grafton and central west, and Wadestown/Thorndon in Wellington, says Davidson. 

For two bedroom flats, for example, some parts of Christchurch still have yields of at least 4%. Then in the biggest category – three bedroom houses – again yields of 4% or more are still conceivable in parts of the main centres, e.g. Christchurch and Dunedin, as well as Gisborne and Whanganui amongst the next tier of towns/cities.

He says new-builds are clearly an option, given the ability to keep claiming mortgage interest deductions from tax, as well as their exemption from the 40% deposit requirement under the loan to value ratio rules.

Davidson says at the other end of the spectrum, there are some low yields in the market. For example, three-bedroom houses are below 2% around a number of Auckland suburbs, such as Remuera, Westmere/Surrey Crescent, St Heliers/Glendowie, and Grey Lynn/Arch Hill, all at 1.7%.

“However, there are always likely to be ‘bargains’ for investors in any market conditions, especially if they get a discounted purchase price or are skilled in renovations, as examples.

“Many investors will tell you that in fact a downturn is the best time to be buying. And no doubt would-be investors will be breathing a little easier on the back of the Reserve Bank’s decision to push out any formal caps on debt to income ratios until at least mid-2023, and even then only if required.”

More costly

It’s obviously become more complicated and costlier to be a landlord, given changes such as Healthy Homes legislation and the extra difficulty in removing a troublesome tenant.

On top of that, says Davidson, mortgage rates have risen sharply, and although an interest-only loan can reduce the servicing payments for the first year or two, clearly no principle is being paid off, and the property may well require a top-up out of other income anyway.

“To be fair, one silver lining from an investor’s perspective is that rents continue to rise at around 6-7% annually, double the long-term pace. But given that tenants’ wages ultimately cap how much they can afford to pay, there’s a limit to how long such rapid rates of rental growth can last.

Market share

CoreLogic’s Buyer Classification data shows mortgaged multiple property owners, typically a genuine investor, have seen their market share of purchases fall over the past year, but at 23-24% they haven’t abandoned property altogether.

Similarly, there are no real signs of existing investors selling properties at a faster rate, with the bright-line test potentially a limiting factor, but also those that have been in the market a while tend to have smaller mortgages and therefore be less affected by higher interest rates.

Of course, for existing landlords who have held property for longer, the pressure will be less acute.

“It still wouldn’t be the biggest surprise if a few more listings come through from existing investors, if they’re outside their Brightline period, in the medium term.

“After all, hanging in for long-term capital gains is one thing, but sustaining cash losses on a yearly basis in the meantime may not be palatable for some investors for too long – especially given the loss ring-fencing rules too."

Tags: landlords

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