How much yield is good when investing in property?

The higher the yield the better, right? Certainly this is the traditional take on yield.

To calculate yield, total up the income you will receive from a property in a given year and then divide this by the value of the property. Yield is expressed as a percentage. It pays to be aware of the dynamics behind high yield, because the higher the yield the better is not necessarily true in all cases.

An example of a situation where high yield alone may not be enough for a sound property investment is in recent trends in some mining towns around Australia. When a mining company sets up a local division of its operations in a small town, it brings a raft of new workers with it. These new temporary residents need somewhere to live, so the company might lease 200 houses in the one town paying $400 per week to rent houses that are worth around $200,000, for example. This works out to around 10% yield, fairly high for residential property.

Does high yield alone make this property a smart buy? Not necessarily. As the yield goes up dramatically, house prices start to follow, as other investors, spurred by the high yield, come into the picture and buy houses in town. This unnaturally inflates the market.

The problem arises when the company decides to wind down or pack up its operations, say five years down the track. Rents return to normal in the area and house prices follow again, this time going down.

If you?d been ?unlucky? enough to buy a property in this town at the peak of the price rise, and then wanted to sell after the company had left town, the prospects of either high yield over the long term, or high capital growth would both be very unlikely.

High yield has to be treated with caution, and it can come at a big price to growth. As an astute investor you must have an understanding of what the dynamics are behind abnormally high yield. To do this, again you'll need to do some research, have local knowledge and understand what trends are active in the relevant market.

For example, in Sydney yield has been rising and is approaching close to 5% at the moment. This is driven by a number of factors, including an influx of new immigrants and a shortage of dwellings. This bodes well for the long term capital growth prospects of the city.

Finding an equilibrium between yield and capital growth is the aim, essentially. And realising, again that markets are determined geographically, with yield changing from area to area.

When you're looking at a period of 10 years, you want the growth. In the ideal scenario, an investor is able to strike some sort of equilibrium where a property with a reasonable yield (therefore keeping the costs down of owning it) also has good capital growth prospects. Generalisations such as ?high yields is always good? and ?low yield generally means overpriced real estate? should never be taken at face value. A little knowledge can be a dangerous thing, and it takes an experienced, educated mind to see through it. For example, waterfront real estate has a long history of low yield, but that does not preclude it from being a good investment, because the potential for capital growth of a waterfront property is so significant in could, in certain situations, outweigh the deficit in yield. So the goal is to find a balance.

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