Thursday, 17 January 2013

Buy to Let: Yield on Residential Rentals (The Bugle)


JP Morgan recently published an analysis of US Monthly Rentals vs. Monthly Mortgage Payments, which made for interesting reading. It indicated the average monthly rental at US$718 and the average monthly mortgage payment of US$481, based on a 20% deposit and 30-year mortgage bond at the current fixed rates offered. With a situation like this it would pay every person to invest in residential property in high rental demand areas, to the absolute maximum of their ability to raise finance and have the cash deposit. This is not the situation in South Africa where monthly rentals are significantly lower than mortgage payments. 

I recently did the exercise for an investment property I have bought and at a 100% mortgage level, the rental paid on a property is only approximately half of what the net yield is. It therefore is still quite a bit cheaper to rent than buy, but this is slowly changing as excessive rental demand bids up rentals on a relatively small stock of available properties. For a property investor weaker house prices can be very good news. As rentals grow and house prices fall, the initial yield on a property increases therefore making it more attractive to invest in residential property as an asset class. Recently Tenant Profile Network (TPN), which has an excellent database of rental property performance, and FNB, which has excellent data on property sales prices, have collaborated to produce the FNB-TPN National Average Gross Yield on Residential Rental Properties data set. This shows that the low point in average rental yields at 6,65% was reach in December 2006, as property prices rocketed, and then started to increase steadily as property prices dropped. The average national rental yield is currently 8,58%. The operating costs associated with a property have to be deducted from this yield to get to a net yield. Rode and Associates have suggested that as a rough estimate one can take 1.5 percentage points off the gross yield to estimate a net yield. At an average net yield of 7.08%, this is still below the cost of finance, currently at 8,5%. 

One fundamental risk every landlord adopts is whether he gets paid or not. TPN estimate that the level of tenants in good standing is currently 83%. That means that 17% of rental tenants had not paid on time. A property investor would therefore require a risk premium in the yield to compensate for this. The question remains then if 8,58% is sufficient to encourage buy-to-rent activity. For me it was sufficient as I see potential upside on both rental growth and price growth. For many investors it is not as yet sufficient as the 4th quarter of 2012 buy-to-let buying is estimated at a mere 7% of total home buying. Nevertheless, in a destination such as Ballito, which is experiencing a significant inward migration of families from the greater Gauteng and Pretoria region, the fundamentals are all correct for investment in buy-to-let opportunities. I have seen the opportunity and put my money where my mouth is. Allow us to assist you to do the same while the opportunity is available.

(Author: Andreas Wassenaar, published in The Bugle 16th January 2013)

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