The gross yield from residential property continued to decline in the first quarter of this year, to 8.34 percent from 8.38 percent in the fourth quarter of 2015, according to the latest residential yields review produced by First National Bank (FNB) and TPN, a credit bureau that specialises in residential letting.

After hitting a low of 6.56 percent in 2007, the average gross yield rose steadily to 8.58 percent in the fourth quarter of 2013.

John Loos, the household and property sector strategist at FNB, said it was possible that yields could decline still further this year, before turning in 2017 as the impact of rising interest rates forces more consumers either to delay buying their own home or to sell their homes and rent.

The gross yield excludes a buy-to-let investor’s operating costs, which would have to be factored into the calculation to arrive at a net yield. Rode & Associates have suggested that about 1.5 percentage points could be subtracted from the gross yield to estimate a net yield, the review said. If this were done, the national average net yield would be about 6.84 percent. Such a yield would not make buy-to-let an attractive proposition for many investors, because the average home loan was above the prime rate, which was 10.5 percent, Loos said.

Inflation, as measured by the consumer price index, was 6.3 percent in June 2016, according to the South African Reserve Bank.

Cheaper properties produced better yields than more expensive ones, according to the review, which segments suburbs into five bands based on the average value of properties. The five bands are:

* Lower-income areas, where the average home value is below R600 000;

* Lower-middle-income areas, where the average value is between R600 000 and R900 000;

* Middle-income areas – between R900 000 and R1.2 million;

* Upper-middle-income areas – between R1.2 million and R1.5 million; and

* Upper-income areas – higher than R1.5 million.

The median gross yields in each area were:

* Lower income: 8.83 percent;

* Lower middle income: 8.73 percent;

* Middle income: 8.13 percent;

* Upper middle income: 7.66 percent; and

* Upper income: 6.13 percent.

Risk vs return

The review said gross yields were not the only factor that buy-to-let investors should consider; they should also look at the risk of tenants not paying their rent. In this regard, the 2.8-percentage-point decline in the percentage of tenants in good standing in the first quarter of 2016 was a concern. The percentage of tenants in good standing was 82.17 percent, down from the high of 86 percent in 2013/14, according to TPN’s latest rental monitor.

TPN classifies tenants as being in good standing if they pay the full monthly rent by the due date, or within the grace period, or late.

The review said it was likely that properties rented out for R25 000 a month or more were in upper-income areas. According to TPN, this rental band had the lowest percentage of tenants in good standing (75.69 percent). In other words, the low yield was not compensating landlords for the high risk.

It was likely that properties in the lower-income band were being rented out for less than R3 000 a month. The percentage of tenants in this rental band who were in good standing (78.69 percent) was also below the national average of 82.17 percent. However, the high yield was compensating investors for the high risk, the review said.

For investors who want a more reasonable trade-off between risk and return, the “sweet spot” remained the lower-income (R3 000 to R7 000) and middle-income (R7 000 to R12 000) rental bands, where the good standing percentages were 85.12 and 87.51 percent respectively.

In the upper-middle-income band, where rents were likely to be between R12 000 and R25 000 a month, 83.58 percent of tenants were in good standing.

In terms of comparing yields by major metropolitan area, the review said there was some truth to the principle that lower risk translated into lower returns. Yields were lowest in Cape Town (7.67 percent) and Nelson Mandela Bay (8.23 percent), both of which have the highest percentage of tenants in good standing.

Johannesburg and Ethekwini recorded the highest gross yield of 8.9 percent.

Sectional title does best

The yields on sectional-title properties continued to out-perform full-title properties, the review said. Two-bedroom sectional properties performed particularly well, with a gross yield of 9.11 percent. They were followed by one-bedroom (8.86 percent) and more-than-two-bedroom properties (8.86 percent).

The view said one would expect the one-bedroom segment, which has the lowest average value, to produce the highest average yield. However, the recent strong buyer demand for these properties, along with the increase in prices, has put a damper on yields.

With regard to the yields on full-title properties, “smaller was better”. Houses with fewer than three bedrooms had the highest gross average yield of 8.05 percent; followed by three-bedroom houses (7.84 percent) and houses with more than three bedrooms (7.13 percent).

DEFINITION

Yield: The annual return on an investment, expressed as a percentage of the capital value. The initial yield is a straightforward calculation in which in the annual rental is divided by the capital value of the property, expressed as a percentage. For example, if the property cost R1 million and the annual rental is R60 000 (or R5 000 a month), the initial yield is six percent. This is the gross yield; it ignores the expenses associated with owning and renting out the property. These expenses must be subtracted from the annual rental to calculate the net yield.

METHODOLOGY

The First National Bank (FNB)-TPN Residential Yield dataset is the combined result of TPN rental data, FNB’s house price data and its automated valuation model (AVM). The methodology takes all of the properties for which TPN rental data exists, uses the AVM to estimate a current value on the property, and then calculates the gross initial yield on all such properties.

Rentals seem to vary far more from the mean than do house prices (possibly because of the absence of professional valuer guidance in the rental market), so the survey uses median yields, not average yields, for rental segments.

The national average yield is a combination of mean and median. The median yields are compiled for the area value bands in the major rental regions (the six major metropolitan areas and “the rest of South Africa”). The median yields of the regional segments are then rolled up into regional and national weighted averages based on weightings determined by the rental volumes in the segments and regions.