Investing for Yield

Recent ultra-low interest rates have distorted the risk-return relationship that’s usually associated with investing for yield. Yield is taking even greater precedence than it has in the past, but how do you identify the best opportunities for yield-based investments?

1. Get the right data

Unfortunately, it’s not as simple as asking an agent for current rents and prices. Yields change, so current prices only comprise a fraction of the picture. To gain a fuller understanding, you need to know where yields have been previously and where they’re projected to go in the future. Once you have enough data about historic yields, you will be able to identify the patterns, but getting that data can be time-consuming and difficult.

Fortunately for you, the REalyse platform brings all the necessary data together.

2. Gross Yields vs. Net Yields

The gross-to-net ratio plays a much larger role in residential investing than in commercial or retail investing primarily because of maintenance — servicing, cleaning, and the cost of a managing agent to name a few. Tenants in secondary market stock — take Victorian terraced houses, for example — would be less willing to cover maintenance and service costs than tenants in new build tower blocks, who are much more familiar with the concept.

Maintenance can affect net yield to varying degrees, depending on rent prices, location, and costs for labour. Consider the differences between two properties: one in Glasgow, one in London. The Glasgow property costs £192,000 and rents for £800/month at a 5 percent yield, and the London property costs £480,000 and rents for £2,000/month, also at a 5 percent yield. The boilers require repairs in both properties and will cost £500 to fix. In the Glasgow property, this additional expense creates a 5 percent reduction in revenue for the year, bringing the net yield to £9,100, rather than the expected £9,600. In the London property, a £500 deduction from the annual rent leaves the net yield at £23,500, or 4.9 percent.

It’s important to understand the dynamics that affect a specific property in order to minimise the gap between the gross and net yields. Many larger investment companies favour new units to older buildings because the operating costs are likely to be better understood and insured.

3. Short-Term Sustainability

There is always the risk that rents may decrease for a particular property type or area, so how do you measure sustainability? There are longer term macroeconomic trends that can impact rents, but in the short term, look out for areas that are comparatively overpriced.

It’s also important to understand the amount of liquidity — transaction activity-in the market. A high-yield area with low liquidity is unsustainable because a vacant property will take longer to fill, and lower demand means lower rental prices. In order to minimise your liquidity risk, monitor changes in the number of rental properties on the market and compare rental numbers in your area of interest to those of neighbouring areas.

In the long run, it is generally thought that investment yields will revert to the mean. However, in the shorter term, property investment yields will be impacted by the prevailing rates in other markets. An increasing yield trend could indicate that rents are increasing or that prices are falling. Each situation confers an opportunity in its own right, if you know how to make use of it.

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