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Raise the bar on Rental Returns


Knowing the ins and outs of the rental market can help you understand how your property will perform in the long and short term. In this issue of Property Insight, we open the door on Australia’s buoyant rental market and provide our top tips on improving returns and boosting your property’s cash flow.

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Rent outperforms capital growth

Rental growth has been outpacing capital growth in all Australian capital cities since the beginning of 2006. Research from RP Data shows that over the last six years, home values have increased by 34.5% while rental growth has increased by 46.8%. Both prices have climbed faster than the inflation rate, indicating that housing is more expensive across the board, regardless of whether you rent or own.

So what does this mean for investors? It means rental returns have become increasingly important. Fortunately, the current environment in Australia means you can expect strong rental returns, with vacancy rates in all capital cities currently sitting below 3 per cent. At this level, the market is considered undersupplied, forcing rental prices skyward. For a full breakdown of annual rental growth and vacancy rates see Table 1.0 (below).


Table 1.0: Annual rental growth and vacancy rates

   Brisbane Sydney
Melbourne CPI
As at June

Vacancy
Rate %

Rental
Growth %

Vacancy
Rate %

Rental
Growth %

Vacancy
Rate %

Rental
Growth %

 Growth %
 2006  2.2  6.2  2.1
 2.0  1.7  1.5  4.0
 2007  1.5  6.6  1.4  4.2  1.4  4.1  2.1
 2008  2.2  9.3  1.1  7.1  1.0  6.2  4.5
 2009  3.0  8.1  1.3  7.1  1.4  6.1  1.5
 2010  3.9  3.7  1.3  4.8  1.5  4.1  3.1
 2011  2.5 2.6
 1.5  5.9  2.2  3.9  3.6

  Adelaide Perth Darwin CPI
As at June

Vacancy
Rate %

Rental
Growth %

Vacancy
Rate %

Rental
Growth %

Vacancy
Rate %

Rental
Growth %

 Growth %
 2006  1.6  3.6  1.9
 4.7  2.4  4.4  4.0
 2007  1.3  4.0  2.1  9.6  1.2  8.0  2.1
 2008  1.5  4.9  2.8  12.5  2.0  8.7  4.5
 2009  1.4  5.5  3.5  9.3  0.8  13.1  1.5
 2010  1.1  4.2  4.3  3.5  1.3  8.3  3.1
 2011  1.8 4.3
 3.5  3.4  2.0  2.8  3.6
Source: Australian Bureau of Statistics and Real Estate Institute of Australia

It’s also interesting to note that the price gap between house and unit rentals is closing. According to RP Data, house rents increased by an average of 5.8% over the five years to December 2011, whereas unit rents increased by 6.2%. This is largely due to demographic shifts and the need for people to live in central locations. It all comes back to the old adage of “supply versus demand”, and demand for units has been strengthening consistently.

Despite subdued capital growth in Australia over the last six years, rental growth has been impressive. In time, we will start to see this balance shift as investor activity increases. Investors and first home buyers will jump back into the market and, when this happens, it is anticipated we will see pressure on supply that will push capital growth upwards. When rents go up, renters typically turn to home buying. When home prices go up, residents turn to renting. This is the seesaw relationship between capital growth and rental returns. This change is not considered positive or negative, just a shift in the market cycle.

At the moment, the seat is high on the side of rental returns and it’s anyone’s guess when the balance will tip. In the meantime, investors can make the most of the strong rental returns.

Increase your rental return even in a buoyant rental market

An additional $10 per week in rent will skim $520 off your holding costs a year; an additional $20 per week will bring your holding costs down by $1,040 annually! As you can see, it is definitely worth considering ways to improve your investment’s return.

To begin with, the rule of thumb is to buy well – in high-demand locations close to amenities, employment and core infrastructure. But there are other smart ways to offer more value to your tenants while increasing your rental return. Keep in mind that we are talking about new or newish properties so renovations will not be factored into this discussion.

Source an excellent property manager

You could manage your property yourself, saving on management fees, but ask yourself: do you have the time and the expertise to do the best job?

In our opinion, an experienced property manager is worth their weight in gold. They will be able to provide a solid understanding of the rental market and will know the potential rate for your property immediately. All good property managers, both real estate and onsite, have databases and tenant waiting lists. Without these resources your property could remain untenanted for weeks, which could cost you thousands.

We always recommend the use of an onsite manager for apartments, if available. An onsite manager has a large vested interest in the property given they usually own one of the residences and have also invested in purchasing the management rights.

Generally, many onsite managers are more ‘handy’ than a real estate rental manager; if a drain gets blocked, most onsite managers will fix the problem themselves rather than call a plumber. Whether onsite or real estate, your property manager should be fully licensed, have a great deal of experience – particularly with your residence type – and be able to provide references.

Provide furniture where appropriate

Furnished properties will always attract a higher rent than unfurnished. A furniture package can impact greatly on your rental yield and in some instances see a negatively geared property transition to positive cash flow. There are two considerations when it comes to furnishing your property: suitability and what to offer.

Firstly, consider whether the location and property type lends itself to being furnished. What kinds of tenants does your property suit? Will a furniture package attract them or could it be a deterrent?

The second consideration is whether to offer a fully furnished or partially furnished residence. A full furniture package will include large furnishings like lounges and smaller items including electrical goods, whitegoods, cutlery and crockery; almost everything needed for everyday living.

Generally speaking, fully furnished properties will provide an extra $100 or more a week return. The downside, of course, is the initial cash outlay for the furniture package, however this is fully tax deductible and depreciable. The real financial benefit of a furniture package is the additional rental income and additional depreciation, which will make a significant impact on a property’s cash flow.

Table 2.0 provides an example of how a full furniture package could impact on your investment property’s cash flow. This example provides a basic representation, only taking into account depreciation and rent over a 5 year period. Please consult with a financial adviser or accountant for a full cash-flow analysis on your property.

Table 2.0: Year 1-5 comparison - unfurnished versus furnished

2 Bedroom, 2 Bathroom, 1 Car Park Apartment

Priced at $550,000

 

Depreciation

Rent

Overall
Unfurnished

 $42,3000

(apartment only)

 $157,300

 ($605 week)

 $199,600 
 Furnished

 $56,8000

(apartment only)

 $180,700

($695 week)

 $237,500 

Additional cash flow from furniture (year 1-5)

$37,900

Additional cash flow minus cost of furniture (year 1-5)

$21,900 ($84 week)


From this long-term example, you can see how a furniture package can impact the cash flow of a property. Despite the initial cash outlay of $16,000, over a five year period, an extra $37,900 was generated from furniture. This is an additional $21,900 if we deduct the initial cost of the package.

If your property is within walking distance of a CBD, it is likely there will be a strong demand for both long-term and short-term corporate lets. Recent projections from PPS tailored furniture solutions, indicate that inner Brisbane, within approximately five kilometres of the CBD, has an average of 30 per cent demand for fully furnished properties. Apartments within 10 kilometres of a CBD also attract long-term corporate tenants, and beachfront properties provide a good option for short-term holiday lets. These types of rentals are positioned well for a full furniture package option.

The other alternative is a partial furniture package that can be varied depending on what the market requires. A common example is a whitegoods package, which would include a washing machine, dryer, microwave and fridge. Offering these items will impact on your rental return each week; $10 to $20 more per week. And, even more so, it may add additional appeal ensuring your residence is rented quickly. Don’t dismiss the potential these small additions could make to your investment’s appeal as well as overall cash flow.

So how do you determine the best way forward? Your property manager should have a thorough understanding of the market and whether furniture package options are in demand in your location. If you get it right, a furnished property in a suitable area can provide handsome returns.

Increase rent in line with the market

While this seems like the most obvious way to increase your rental return, it is amazing how many landlords fail to increase the rent consistently to market standard. As mentioned previously, an extra $10 to $20 week could make a real difference to your property’s cash flow.

Let’s take the last six years as an example: rental growth has increased on average 46.8%. Starting with $300 per week rent in 2005 the gradual increases over this period would add an additional $140.40 per week now in line with current market movements. That is $7,300.80 a year additional cash flow!

Increasing rent is, of course, a balancing act – you don’t want your previously loyal tenants moving out due to a massive rental hike, and the property may remain vacant for weeks. When you have loyal tenants, marginal rental increases in line with market movements are recommended. Hiking the rent up all in one go after many years is unfair to tenants. When a new tenant moves in you can set the rent at the market standard but, remember, it often pays to be a little competitive so the vacancy period is minimised.

Sitting pretty with high rental returns

Australian investors are enjoying strong returns in the current rental market, but there’s always room for improvements – and now is the time to make them! The key is to ensure you are optimising your returns, whether it be reviewing your property manager’s performance or considering some type of furniture package.

We recommend speaking with your property manager regularly to stay on top of market movements and tap into their experience and expertise in the market.


 

DISCLAIMER: Whilst the publisher and author believe that the information contained in the publication is based on reliable and researched information, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. Anyone who intends to use the information as the basis for making financial or business decisions should first obtain advice from a qualified professional person. This article is published on the understanding that neither the publisher nor the author - is responsible for the results of any action taken on the basis of the information published; and is not engaged in rendering legal, accounting, professional or other advice or services. The publisher and author expressly disclaim all liability and responsibility to any reader of this publication as a consequence of anything done, or not done, by a reader relying upon any part of this publication. (C) This article may not be reproduced in full or in part without the specific written consent of Which Property? and the Author.

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