Higher yield = Higher Risk?

[Monid]

Hi guys

one of the most commonly repeated statements about investments is that in general the higher the return then the higher level of risk is.

Whilst there does seem to be some truth to this othodoxy, I wonder if it always holds true or is even a good general rule for property investment.

secondly this rule is usually applied for warning people off small town high yield properties but I wonder if given that property allegedly has two different income streams (Cashflow and Capital Gains) it ought also be used to criticise factoring in a high expectation of capital gains.

What makes me wonder about the rule is that with our better quality lower yeilding properties in a good neighbourhood, we can only have it sit empty 6 weeks of the year and we would lose money.

with one of our cheaper properties in small towns we can afford to have them untenanted for 16 weeks and still break even over a year.

it seems to me that unless vacancy rates are drastically different the cheaper properties are safer at least in terms of raw cashflow and being tenanted.

Now of course it might be that smaller towns attract a worse quality of tenant and so are more risky in this regard, but that seems a bit unfair the equation small towner=thug seems unlikely. Likewise if you buy in a small town you can often afford a better quality house and thus in theory at least attract a better quality tenant than you can in a similar priced property in a larger town.

SO what do people think does the rule of thumb, higher returns = higher risks hold true in real estate?

[cube]

Hi,

I'd have to say yes, because any particular properties market price is dictated by how much someone is prepared to buy to own it.

If a property in street A is the same as a property in street B but has a market price 20% lower, then you have to ask why, and that will come down to some things that you can influence (quality of tenants, state of property) and some you can't (quality of neighbours, power lines overhead).

Given that most decent, hardworking folk would all like to live in a quiet area with nice neighbours and no power lines, those uncontrollable factors are going to limit your tenant base to either those who can't afford anything else (lower rent, but they leave as soon as they can) or those who don't mind the noisy neighbours because they are like them

2c

cube

[Monid]

Hi Cube
well I agree and disagree with your point. Market price in a perfect market would be found precisely the way you describe. And this model explains the votility of the stock market because it is a very good market.


However the housing market is far from a perfect market and is clouded by there being buyers with different purposes involved ie first home buyers, cashflow investors, capital gains investors etc.

furthermore it is rare for house buyers to either have full information or for the entire market to be exposed to the property in the appopriate way.

So it is unclear that the price achieved in the sale of a property reflects it's soundness as an investment though I think they will often be related.

cheers David

[orion]

SO what do people think does the rule of thumb, higher returns = higher risks hold true in real estate?

Overall no, I don't think higher returns = higher risk, but in some cases with buying in smaller towns, it may be riskier - not because of the higher yields, but because of small changes in the town itself that may affect prices far more than in the larger cities.
Also, lower yields can be higher risk if you go too low. If you look at what is happening, especially in Australia with many investors buying properties with 1 - 2% yields, that to me is far more risky than buying something with an 8% yield - the risk is because it doesn't make sense to buy investments with so much equity used per property to get a neutrally geared situation. In fact, it is outright stupidity. And what makes it even worse is that they are usually on interest only.

Regards
Graeme Fowler

[Scallywag]

Is higher yield (on residential property) related to risk ?

Maybe sometimes, but isn't it more related to perceived capital gain?

Take two suburbs in one city, one with high yield and one with a low yield, you can bet your last dollar that the perception will be that the suburb with the higher yield will have a lower capital growth.

[orion]

Take two suburbs in one city, one with high yield and one with a low yield, you can bet your last dollar that the perception will be that the suburb with the higher yield will have a lower capital growth.

Yes, that could be true. The perception may be that with many investors, but not my perception.

Regards
Graeme