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Rental property returns depend on capital gains

11:00 AEST Fri Jan 7 2011
National operating returns
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Investing in rental property can be a complicated and risky exercise so it’s worth digging through the details of what influences profits and whether the market looks good value at the moment.

Currently anyone wanting to make profits over the longer term will require property prices to rise because the net cash flows from rental returns are barely positive nationwide.

Property price appreciation has helped generate better returns than bank term deposits in the past, but similar gains in future will require further rises in property prices because rents aren’t high enough to produce returns higher than those from a bank term deposit in almost all regions.

So how can potential investors work out the potential returns and put them in the context of what has happened in the past?

The Residential Property Investors (RPI) report compiled by every month in association with Bank of New Zealand tracks the performance of rental property in all the different regions in New Zealand and includes comparisons going back to 2006.

It pulls together all those influences on returns – including rental incomes, rates, interest rates, maintenance, insurance, depreciation and house price appreciation – to come up with a single figure expressing the profit after tax as a percentage return on the equity invested.

The reports make many assumptions, but they give a broad idea of the direction and size of those returns. Every property is different, but these reports give a general idea about the current state of the market both nationally and regionally.

In October the report for New Zealand showed rental property returns after tax but before capital gains at 1.8% and returns after capital gains and tax at minus 0.5%.

This is below after tax returns from a one year bank term deposit of 3.65%.

National all in returns

However, rental property returns after tax and capital returns have improved significantly in the last two years from as low as minus 25.6% in December 2008; that’s because of lower interest rates and a slight rebound in house prices in 2009. The chart here shows that returns have been much more volatile than bank term deposits, but higher than bank returns for much of the last four years.

This all depends on capital gains.

Rental property returns before capital gains have been lower than bank term deposits for all of the last four years although there has been an improvement over the last two years because of lower interest rates.

Article provided by BNZ.