Why do we calculate yield in property investment

[PTILoveYou]

Buy something with the yield you want, finance it, then keep it and don't intend on ever selling it.

Yup I agree, there are far better things to do than playing with a calculator!

[Wayne]

If you keep doing that, you are most likely liable for tax on all gains and you need to keep looking for higher yield opportunities which you may or may not find.

This certainly is something to keep in mind.
If there was nothing better you wouldn't sell - you need to work out 'what else' before you sell.

Personally I don't do this but that's the theory.

[Rosco]

Do you never review your portfolio?

Every year, I try to review my portfolio, my strategy and my aims/goals.

I look at gross yield as a quick comparison between properties. And yes, based on current value.

My view is if you have purchased say 10 properties, that you will get one wrong, and probably need to sell it as it is no longer helping you meet your investment goes. Then reinvest in something that does meet your goals.

So it is quite normal and realistic to sell a few rentals. This doesn't make your whole portfolio taxable!

An example - you have purchased a 12% gross yield in Tokoroa. Over time the property is now worth twice as much, but rents have actually dropped a little, and you are really struggling to get 48 weeks of rent due to vacancies and tenants not paying well. There is also some major repairs coming up in the next few years as well.

Wouldn't you sell this example, if you could then buy a better property?

Ross

[Damap]

It would be foolish to not review portfolios but once every 5 years is probably enough. Assuming you are in a main centre that is and not bottom feeding.

[orion]

Do you never review your portfolio?

Every year, I try to review my portfolio, my strategy and my aims/goals.

I look at gross yield as a quick comparison between properties. And yes, based on current value.

My view is if you have purchased say 10 properties, that you will get one wrong, and probably need to sell it as it is no longer helping you meet your investment goes. Then reinvest in something that does meet your goals.

So it is quite normal and realistic to sell a few rentals. This doesn't make your whole portfolio taxable!

An example - you have purchased a 12% gross yield in Tokoroa. Over time the property is now worth twice as much, but rents have actually dropped a little, and you are really struggling to get 48 weeks of rent due to vacancies and tenants not paying well. There is also some major repairs coming up in the next few years as well.

Wouldn't you sell this example, if you could then buy a better property?

Ross

Not now Ross, maybe in the early days but there is no need to now.
All the rentals I hold now are good properties, in good locations and attract good quality tenants and I will hold them until they are all fully paid off.

In the earlier years, yes there were a few that turned out to be not that great. But that’s such a very small percentage of properties, and not something I would need to sit down and review all the properties one by one to see if I still wanted to hold onto them.
If you buy in places like Tokorua or Wairoa for example, you may experience times when you have high vacancies etc, so in those instances it would probable make more sense to sell yes.

[Anthonyacat]

Some of the properties I have now are worth well over twice as much as when they were bought many years ago.
If I did a yield calculation now it would be around 6%.
To increase that, it means you sell and buy something higher yielding.
If you keep doing that, you are most likely liable for tax on all gains

A couple interesting points here. The first is the tax on gains, which I can say absolutely that if you're selling your property because it is no longer a good investment (ie, you wouldn't buy it based on its current fundamentals) that's a good argument against taxable gains. There was in fact a case providing precedent for this that I studied in a tax course, though I can't remember the name. The defendant bought many properties and sold those which performed worst every year. The court found he did not purchase any of them with intention to sell, and so no taxable gains. You'd need to read the full case to get all the details of course. There are always complexities.

As for the other point, to buy and never review. It's a very interesting point, and hinges on investment efficiency. If you have access to a pool of safe rentals grossing 10%, and you hold a portfolio of rentals which you purchased at 10% but are now returning 6%, why would you not sell those you have, and buy those which will earn you more? I can see three reasons:

1) Transaction costs. Legal fees & agent costs. But at a certain point it still makes mathematical sense to pay these for a higher return.
2) Risk aversion. You know your current property is good. The others only mightbe good. But an experienced investor is capable of fairly consistent judgement.
3) The sense of 'enough'. The buying and selling takes effort, as does the reviewing. Why work hard to earn more, when you're satisfied with what you have?

My guess, Graeme, is that you fit the third.

[James.wu]

Thanks a lot guys, I have a better understand now.

[ivanp]

If you have access to a pool of safe rentals grossing 10%, and you hold a portfolio of rentals which you purchased at 10% but are now returning 6%, why would you not sell those you have, and buy those which will earn you more? I can see three reasons:

1) Transaction costs. Legal fees & agent costs. But at a certain point it still makes mathematical sense to pay these for a higher return.
2) Risk aversion. You know your current property is good. The others only mightbe good. But an experienced investor is capable of fairly consistent judgement.
3) The sense of 'enough'. The buying and selling takes effort, as does the reviewing. Why work hard to earn more, when you're satisfied with what you have?

Why would some rental property earn more (do you mean higher gross yield?) than the current one, assuming that the current one was purchased well (i.e. you didn't pay to much, and it doesn't have serious negative sides like bad location, or bad construction, etc)?

I guess because the one that [looks like] earns more is either in cheaper/worse location of the same city/town, or it is in a smaller town, than the existing rental... Both cases sound like more trouble - more maintainance, longer vacation periods between tenants, more troubles from tenants to manage, etc. So probably actual expenses will be higher than you would expect, and net yield not as good as you would expect, and it earns not that much more than the current one to justify all the hassle

[Nick G]

He's saying that when he bought it was 10% but the value went up faster than rent and if you were to calculate yield to value and not PP it would be just 6% on today's numbers.

[Wayne]

He's saying that when he bought it was 10% but the value went up faster than rent and if you were to calculate yield to value and not PP it would be just 6% on today's numbers.

And I think ivanp is suggesting that any alternative investment property of a similar standing (good house, good area etc) will have gone up in value similarly (with the consequent compression of yield).

But if you don't review you don't know.
A review doesn't have to be hours spent pouring over numbers.
You should know what the maintenance has cost.
You know all the other values.
5-10 min a house is all it should take.

[orion]

A couple interesting points here. The first is the tax on gains, which I can say absolutely that if you're selling your property because it is no longer a good investment (ie, you wouldn't buy it based on its current fundamentals) that's a good argument against taxable gains. There was in fact a case providing precedent for this that I studied in a tax course, though I can't remember the name. The defendant bought many properties and sold those which performed worst every year. The court found he did not purchase any of them with intention to sell, and so no taxable gains. You'd need to read the full case to get all the details of course. There are always complexities.

As for the other point, to buy and never review. It's a very interesting point, and hinges on investment efficiency. If you have access to a pool of safe rentals grossing 10%, and you hold a portfolio of rentals which you purchased at 10% but are now returning 6%, why would you not sell those you have, and buy those which will earn you more? I can see three reasons:

1) Transaction costs. Legal fees & agent costs. But at a certain point it still makes mathematical sense to pay these for a higher return.
2) Risk aversion. You know your current property is good. The others only mightbe good. But an experienced investor is capable of fairly consistent judgement.
3) The sense of 'enough'. The buying and selling takes effort, as does the reviewing. Why work hard to earn more, when you're satisfied with what you have?

My guess, Graeme, is that you fit the third.

Hi Anthony,

The tax issue is one you would have to get good advice on - and then still may not know the correct answer
The rules all changed a few years ago with the association rule.
I know in the early days I didn’t have to pay tax on any of the ones I sold.
But one I sold in the new buy and hold trust I set up last year, I had to pay tax on the one that was sold.
I questioned my accountant on it, but he said yes, I was definitely liable for it on that one.
He is one of the most experienced accountants in NZ and anything he is unsure of he asks a guy that taught him in Wellington, and he helped write some of the NZ tax law.
The IRD will often call him if they are unsure of the interpretation of certain rules.

I know of others that have had advice from other professionals such as GRA and NSA and my accountant had said, no they can’t do it that way and found out later that was true.
It’s a subject I know very little about and leave it to my accountant who I believe knows the rules better than 99.9% of others in the industry in NZ.

In answer to why buy and not review: - partly number 2 and 3 that you mention, but more about choosing them well and let each property stand on its own and pay itself off. So, there is no need to review them, compare them or look at selling them to replace them with something else.

[Wayne]

But one I sold in the new buy and hold trust I set up last year, I had to pay tax on the one that was sold.
I questioned my accountant on it, but he said yes, I was definitely liable for it on that one.

Did he say why?

[orion]

Did he say why?

He did at the time but don't recall now.
Not something I needed to remember so didn't take too much notice.

[klauster]

Yield or ROI – a measurement for “value for money”
Yield has the preference to compare and make purchase decisions and net yield (like ROI) is a figure for profit or not.

If you run your investments as business, you will annually look at your ROI, and use yields to make decisions for buying and selling as it relates to the property market. As a business you have expenses which are not rent deductible but they reduce your ROI. Everything is based on your business model, investing rules and what your goals are.

[James.wu]

Yield or ROI – a measurement for “value for money”
Yield has the preference to compare and make purchase decisions and net yield (like ROI) is a figure for profit or not.

If you run your investments as business, you will annually look at your ROI, and use yields to make decisions for buying and selling as it relates to the property market. As a business you have expenses which are not rent deductible but they reduce your ROI. Everything is based on your business model, investing rules and what your goals are.

Hi Klauster

This make it very clear for me, thanks a lot!!