What you'll learn in this step: Returns come from capital growth and from rental income.

What you'll learn in this step: Returns come from capital growth and from rental income.
Capital growth

Capital growth is the increase in the value of your property over time and is one of the main reasons people invest in residential real estate.

Historically, Australian residential property has experienced strong capital growth – the long-term average annual growth rate for property is about 9 per cent – but periods of stagnation and even decline are also part of the picture. The nature of the property cycle means real estate should probably be thought of as an investment with a 10-year horizon.

Take the experience in recent years. In 2003, Australian house prices were rising at a rate of about 20 per cent, but since then prices have come to a virtual standstill in many areas and have gone backwards fast in some of the hot spots.

Your best chance of achieving capital growth is buying the right property, in the right place, and – most importantly – at the right price.

Research current house prices. Keep an eye on sale and auction results in the papers, or buy reports on specific suburbs from researchers like Australian Property Monitors’ Home Price Guide (www.homepriceguide.com.au). Talk to real estate agents and observe at auctions.
Rental income and yield

You should apply the same standards to a property investment as to any other investment, ‘benchmarking’ the potential return against what you might achieve elsewhere.

An important measure is a property’s yield. That can be calculated by dividing the annual rent it generates by the price you paid for the property and multiplying that by 100 to get a percentage figure.

Let’s say you bought a unit for $400,000 and rented it out for $350 a week (or $18,200 a year). That’s a yield of 4.5 per cent. That might compare with a dividend yield of, say, 7 per cent had you invested in a particular company’s stock.

But let’s say you bought a worker’s cottage in a mining town where prices are low but the rental income as good as in the big city. Pay $350,000 and rent the property out for $600 a week and you’ll achieve a yield of 9 per cent.

Remember, yields fall as house prices rise (if rent doesn’t rise commensurably).

Keep an eye on vacancy rates – the proportion of properties sitting empty out of the total rental supply.

If landlords have to fight for tenants, they won’t have much ‘pricing power’ with regard to rent. However, if the rental market is tight, and tenants are competing for properties, they’ll be prepared to pay a bit more to get in the door.

A vacancy rate above 3 per cent is a warning sign, and it may pay to be wary of areas where there’s going to be a big increase in the supply of apartments.

In any case, build into your calculations of your likely return periods when you’ll be in between tenants.