Yield and capital gain: two keys to real estate returns

There are two important concepts that any property investor needs to be aware of - yield, and capital gain.

Yield is the expected annual rental return, expressed as a percentage of the purchase price.

The average yield in New Zealand is 6 per cent, although this varies significantly across regions.

The highest average regional yield is in Otago (9.1 per cent) and the lowest is in Northland (5.4 per cent). Auckland is at the lower end of the spectrum, at 5.6 per cent.

The yield, combined with the terms of the mortgage, determines how much personal money (in addition to rental income) the investor has to spend to acquire the property.

As a general rule, a property will be self-funding over 25 years if it yields at least the mortgage interest rate plus 2.5 per cent (excluding an initial 20 per cent deposit).

This covers regular expenses such as rates and wastewater, as well as standard maintenance and upkeep. At current interest rates a yield of around 10 per cent would be self-funding.

Capital gain is the profit derived from selling an asset for more than it cost, generally expressed as an annual percentage growth rate. Capital gain is usually estimated by using changes in average property prices, although such measures can be misleading when there is rapid growth and/or improvement in the housing stock.

However, in the absence of superior data, movements in average prices provide the best estimates of capital gains.

Over the past five years the average price of residential property in New Zealand has increased by 2.8 per cent a year.

Like yields, capital gains vary significantly across regions, and within regions. The highest capital gains in the past five years have been in the Pukerua Bay/Tawa area of Wellington (8 per cent a year) and the lowest on the West Coast (minus 3.6 per cent a year). House prices in Auckland have changed by between 3.5 per cent a year (Devonport) and minus 1.9 per cent a year (Panmure) over the same period.

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