While our sales team would be delighted with a "14% rental yield" to pitch to their customers, my fellow directors and I usually have to look at the bigger picture. The simple truth is that high yields are directly proportional to the level of risk involved. A buyer who chases the highest possible initial yield will neglect to consider several critical factors that determine the true profitability of his/her purchase.

 

Experienced investors don´t make that mistake, and there are many scenarios where they will deliberately choose a lower yield for a higher quality property. I am fortunate to have a job that allows me to spend a lot of time speaking with these kinds of people and I´ve learnt quite a lot from them over the years.

 

Experienced property investors generally look for the following: 

 

Predictable and stable returns

Renting to stable professionals in full time jobs earning above average salaries is the best way to ensure a continuous and hassle free income stream.  People outside of these categories tend to move around more, which leads to vacancy periods.

 

It is much better to earn a modest but consistent rental income compared to a volatile rental income that varies sharply from year to year. In other words, it is preferable to earn $7000 every year, as opposed to $9000 some years and $5000 other years. The reason is simple: it is very difficult to plan future investments if your income stream is unreliable.  

 

A well maintained community

It makes sense to pay more for a property in a very well maintained community. This creates a lot of stability for the landlord as unexpected expenses and tenant turnover will be much less frequent. An unplanned increase of several hundred dollars per month in your community (HOA) fees can wipe several percentage points from a rental return. 

 

While some aspects of a well maintained community are easy to spot (no rubbish, trimmed grass, freshly painted exteriors, clean swimming pool and clubhouse etc.) others take a little more investigation. For example, the roofs on all the buildings need to be replaced after 20 years, and if a reserve hasn´t been built up, all the property owners will have to pay a lot extra to get it done. 

 

Neighborhoods with a low crime rate and a high average income

Very often, the highest yielding properties are located in lower income neighborhoods. This happens because the purchase price is proportionately much lower than the reduced rents available. For example, in a two star neighborhood, you could buy a property for $50,000 which will rent for $700 per month. That is a 16.8% gross yield. In a four star neighborhood, you could buy a property for $80,000 which will rent for $900 per month. That´s a 13.5% gross yield.

 
 

While 16.8% sounds better than 13.5% on paper, it is worth noting that properties in two star neighborhoods will have higher crime rates, higher unemployment, higher tenant turnover and higher repair costs. Not exactly a recipe for a stable and hassle free income.  

 

Tenants in lower income neighborhoods are also much less willing to absorb rent increases - so you´ll have to suck up any increases in the running costs yourself. An extra $50 per month is a lot of money to someone on the minimum wage. On the other hand, people earning comparatively higher salaries who are happily renting in well maintained communities can and will absorb regular rent increases. 

 

If your property is empty, you are losing money. It´s that simple. Real yields come from stable tenants. 

  

Lower management fees

You may not notice it at the beginning, but the small print in every management contract will contain additional fees to oversee a property with high vacancy rates and high repair costs.

 

A professional investor will pay more to own a property in a well maintained community that attracts tenants with high credit scores to protect who are able to pay higher deposits. Tenants like this have more skin in the game and are much more likely to take care of their property. This is a virtuous circle that leads to lower vacancies, much lower management fees and a higher annual income. 

 

A property with these characteristics will always sell for a premium in the long run.  

 

So how might one go about finding these kinds of properties? 

 

Firstly, in property, as in everything else, you get what you pay for. 

 

Secondly, the adverts and the glossy brochures generally don´t tell you anything about the stability of the rental returns, the financial health of the community or the disposable income of the tenants.

 

You have to do a lot of digging to find a property that will supply a steady income stream and can be sold for a premium in the future. Torcana has a checklist the length of your arm that needs to be ticked once a potential deal clears the first few due diligence hurdles.

 

However, you´ll avoid the majority of mistakes and nasty surprises first time investors experience if you can locate properties with the following characteristics: 

 

1. FHA approved financing available (or likely to be available soon) to owner occupiers

2. Low foreclosure levels

3. High owner occupancy and low vacancy levels

4. Low levels of unpaid HOA fees 

5. Little or no evidence of deferred community maintenance

6. An adequate HOA reserve to cover future maintenance work (i.e. those new roofs)

7. Located close to quality schools, major employers and important infrastructure

 

If your seller can satisfactorily answer the questions above, you may located a very solid deal. If they are reluctant or unable to provide this information, and instead keep referring you to the great purchase price and the great yield, then the property is unlikely to match the key criteria above that experienced investors look for.

  

Conclusion 

Imagine for a moment that you are buying a second hand car. Sure, the price tag and the mileage are important considerations, but most of us would also get a qualified mechanic examine the brakes, the engine, the tyres, the paintwork, the battery, the ignition etc.

 

The point I´m trying to make is that buying a property solely based on its price and current monthly rental yield is a bit like buying a car because it looks nice. 

Purchasing a property is right up there with the most important financial decisions a person has to make. At Torcana, we take that responsibility very seriously indeed when promoting products to our clients. 

 

The subject headings on our emails might not be as flashy as some of our competitors (14% yields! Guaranteed Finance! From $30,000!) but our aim is to sell great properties with a real income stream and genuine resale potential. 

 

If you like the sound of that, then we´d really love to talk to you.