At the end of the day, property investment is about one thing - return on investment. So what kind of returns should you expect from an investment property?
Where does my return come from?
Two areas - rental yield and capital growth.
Rental yield is income you receive each year from the tenant in your investment property, measured as a percentage of the value of the overall property. Gross rental yield is the amount of rent your tenant is paying, and net rental yield is the amount you pocket after all of your costs, such as management, maintenance, rates, water and insurance. If you have a property worth $1,000,000, your tenant pays $50,000 per year in rent and you pay $10,000 a year in costs, you have a gross rental yield of 5%, and a net rental yield of 4%.
Capital growth is the appreciation of the value of the asset itself. This can be a negative return, if the value of the asset declines. If you a buy a property worth $1,000,000 and it increases in value over 5 years to $1,500,000, then you have achieved capital growth of 50% overall, or 8.44% per annum.
What return should I expect from my investment property?
The ASX and Russell Investment's Long-Term Investing Report determined that the average gross (before tax) return from residential property from 1995-2015 was 10.5% per annum.
Property is a growth asset, not a defensive one, and as such should comfortably outperform the rate of inflation over the long-term. If only held for the short-term, you run the risk of negative returns due to capital losses.
What difference does location make to my return?
10.5% per annum is a great rate of return, and most investors would take that every day of the week. Indeed, if every property investor achieved these returns, Australia would have a lot more investors with more than 2 properties than the current 10%. Unfortunately, results vary dramatically depending on where you choose to invest.
Let's look at some examples from Queensland, from 1993 until the end of 2016. Australian property has a good run over this time, driven by financial deregulation, greater workforce participation and an economy 25 years now without a recession. So returns should be good. How did different locations perform?
One investor buys an established house in Wavell Heights in Brisbane, approx. 12 kms north from the CBD at the median price of $125,000. The median price in the suburb is now $652,000, which is a gain of $527,000 and means a return from capital growth of 7.44% per annum. It's harder to calculate return from rent, but the median rent is now $450 per week, which is a gross rental yield of 18.72% per annum on the original purchase price.
Another investor bought a property in a new housing estate in the suburb of Kallangur, approx 30kms from Brisbane' CBD, at the median price of $106,000. 23 years on, the median price is now $365,000, which is a gain of $259,000, or 5.52% per annum. Not a bad return by any means, but its less than half the gain of the Wavell Heights property. Kallangur likely had a higher rental yield than Wavell Heights to begin with, and still does, but its median rent of $350 per week is a lower rental yield on the original purchase price - 17.16% instead of 18.72%
A third investor bought a house in Townsville, in the new suburb of Annandale. They shelled out $167,000 for the property. The median price in the suburb is now $370,000. This is a growth rate of only 3.51%, and is a much lower gain on a much higher outlay. The median rent today of $380 confers a rental yield of 11.83% on the original purchase price, again, well below the other examples.
So location can make a big difference in how your property performs. An established house in an inner suburb comfortably beat a new property in an outer suburb, while both capital city properties outperformed their regional counterpart. It's also clear that while a strong rental yield is important, so is the growth in the absolute rental return from the property. This is why the Wavell Heights property outperformed Kallangur in rental return, even though it has a lower rental yield.
This is a theme repeated throughout Australia, with capital cities providing the strongest and most stable growth, and the inner suburbs providing better returns than the outer suburbs.