Currently low rental yields suggest negative cash flows could be a possibility for mortgaged investors

Residential property continues to be a challenging market for investors, with rental yields remaining at modest levels, as capital gains all but dry up.

Interest.co.nz's calculations show a property purchased at the Real Estate Institute of New Zealand's lower quartile price for March ($610,000) and rented at the median rent for new tenancy agreements in March ($595 a week according to the Ministry of Business, Innovation and Employment), would have a gross rental yield of 5.1%. That's unchanged from February, but down slightly from 5.2% in March last year.

The rental yield is the amount of rent a property could receive in a year, expressed as a percentage of its purchase price.

A 5.1% return may not seem too bad when you consider that most banks are paying less than 5.0% for term deposits up to five years, or slightly more for a PIE term fund.

Of course there's a catch, and it's that the rental yield figures quoted above are gross, which means the 5.1% return is before allowing for outgoings such as rates, insurance and maintenance and any administrative costs such as property management and accounting fees, all of which the investor usually has to pay.

These costs will likely considerably reduce the rental income down to below the returns available from a bank term deposit. On top of that, if the property suffers a period of vacancy and the resulting loss of rental income, the returns will shrink even further, likely pushing it into the realm of low yielding investments.

Additionally, the above figures assume the property would be purchased without a mortgage i.e., the 5.1% gross rental yield makes no allowance for any mortgage payments.

If a mortgage is factored in, it would have a major impact on the investment's cash flow.

Based on the example above, if a property was purchased at the REINZ's March lower quartile price of $610,000 with a 60% mortgage ($366,000), interest.co.nz estimates the mortgage payments* would be equivalent to $559 a week.

At the median rent of $595 a week, that would leave just $36 a week to cover rates, insurance, maintenance and any other costs, so the investment would almost certainly have a negative cash flow, with the investor having to cover the shortfall from other income or reserves.

In the absence of capital gains, that is not a good position to be in, and with mortgage interest rates likely to keep rising, those cash losses are likely to get bigger, making property investment an even less attractive option, unless you can make a purchase with a very modest mortgage.

Which is good news for first home buyers, who like investors tend to be more active in the bottom half of the market.

That's because first home buyers do not need to worry about an investment's return, only about how much they can afford to pay.

So with less competition for properties from investors, first home buyers have more of the market to themselves.

*Mortgage calculation based on the average two year fixed rate in March of 5.05% and a 20 year term.