Negative cash flows likely still an issue for many residential property investors even though interest rates are falling

The returns on residential investment property remained poor in the third quarter of this year (Q3), although the decline in mortgage interest rates improved investors' cash flows, according to interest.co.nz latest residential rental yield and cash flow calculations.

Interest.co.nz tracks quarterly changes in the the Real Estate Institute of NZ's lower quartile selling prices and rental bond data. This is to calculate indicative gross rental yields for three bedroom houses and one and two bedroom units/apartments, in all of the main urban areas around the country.

We also use the above data to calculate how much of the rental income from those properties would be left over after the mortgage was paid, assuming the mortgage was for 60% of the lower quartile price and over a 20 year term.

As usual, there were significant variations by property type and location.

Three bedroom houses are generally a poor investment

For three bedroom houses there was very little movement in either the lower quartile price or the median rent at the national level between Q2 and Q3.

The national lower quartile price for three bedroom houses declined marginally from $585,000 in Q2 to $580,000 in Q3, while the median rent for the same was unchanged at $650 a week, which meant the gross rental yield was also unchanged at 5.8%.

The only meaningful change was in the mortgage interest rates used in the calculations, which declined from 6.5% in Q2 to to 5.68% in Q3.

That substantially increased the cash surplus left over once the mortgage was paid, from $47 a week in Q2 to $133 a week in Q3.

Although that appears to be a significant improvement, it's still a very poor return, because the landlord would still have to pay expenses such as rates, insurance and maintenance from the surplus and also allow for periods of vacancy when there was no rental income.

The situation is even worse for three bedroom houses in high cost areas such as Auckland, Tauranga and Queenstown, where the gross rental yields remained below 5% in Q2 and cashflows were still strongly negative, although the outflow of cash has been reduced form Q2. See the first table below for the indicative yield and cash flow figures in all main urban districts.

Essentially what these figures show is that three bedroom houses are mainly a poor investment from a cash flow perspective and investors buying at Q3 metrics would be heavily reliant on future capital gains to eventually make some meaningful money.

Rents and selling prices of two bedroom units both in decline.

There were small declines in both the REINZ's national lower quartile price and the median rent for multi-unit properties with two bedrooms in Q3 this year.

The lower quartile price dropped from $427,875 in Q2 to $420,000 in Q3, while the median rent for these properties declined form $600 a week to $590.

However one balanced out the other in the yield calculation which remained unchanged at 7.3%.

The bright spot for the two bedroom units was the decline in mortgage rates, which pushed the post-mortgage cash surplus up from $159 a week to $184. That's the highest cash flow of the three property types monitored in this series, suggesting they may be occupying something of a sweet spot in the market for investors at the moment.

One bedroom units/apartments show big price gains - lower yields.

There was a substantial increase in the REINZ's national lower quartile price of multi-unit properties with one bedroom,  which rose from $215,000 in Q2 to $269,500 in Q3 (+25%), while the national median rent for these types of properties declined slightly from $460 a week to $450.

That pushed their indicative gross yield down from 11.1% to 8.7%.

The higher median price also pushed down the indictive post-mortgage cash surplus, from $238 a week in Q2 to $150 a week in Q3, even after allowing for the decline in mortgage interest rates.

One bedroom units have traditionally provided the best rental returns for investors so are less reliant on capital gains. Although in certain markets, such as central Auckland, overseas students make up a large proportion of their tenants, which can make the returns subject to high levels of vacancy from time to time, meaning their returns can be volatile.

In particular, this shows up in the one bedroom table below for those properties in Auckland's Waitemata & Gulf Ward, which provides staggering indicative yields of 19.5% and post-mortgage cash of $334 a week.

That's nice money if you can get it, but of course if something seems too good to be true then it probably is, and those figures are no different.

One of the main reasons the one bedroom apartments in this part of Auckland provided such apparently fabulous returns is that large numbers of them are on leasehold titles, which means they can sell for very low prices.

Although that provides a high gross return, much of that cream will be siphoned off by ground rent payments, which along with allowances for vacancies, will bring net returns back to more realistic levels.

This can be a trap for inexperienced investors who are unfamiliar with the ins and outs of this particular niche market.

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