When investing in any asset class, investors should be aware of yield compression, the importance of that, and how it affects capital value going forward.
Yield compression is the changing perception of risk in an investment. I wrote a couple of weeks ago about Risk vs Reward and how that pushes investment values one way or the other on property investment. Well, yield compression is the market’s decision that the growth and security of an income stream has become stronger. A stronger investment means a lower risk profile and therefore purchasing at a lower yield/return. I’ll explain that:
Say you have two investments, both student buy to lets, both producing a net rental return of £15,000 pa. One is in a relatively untested area and has only been achieving this figure for the last year, the other is in a more established area and has been achieving 100% occupancy for 5 years. Which is the lower risk investment? Most would say, the more established investment and therefore, purchase that property.
If you are able to pinpoint an area where there’s likely to be strong demand over the coming years and you can purchase at a very good price, yield compression will be your best friend. An example of how our clients at Fresh Invest have done just that is:
A few years back we worked with a developer to bring to market 9 x 6 bed HMO houses in Liverpool. All were brand new, in a good student area, but weren’t sold with any rental assurance; so client’s had to trust us on that! We sold all of those properties on a net yield of around 11% on expected rental levels. All houses were 100% occupied for completion, so clients took a small risk and it paid off. Since this time, a few years ago, all of those houses have remained 100% occupied and our investors have had great rental returns. If/when any of those investors choose to sell, the likelihood is that anyone looking to purchase will take note of the fact they now have a long standing track record of occupancy and deem this a less risky investment, probably around the 9% net yield figure. In this yield compression there is inherent capital growth, example below.
£20k net income at an 11% net yield = £180k
£20k net income at a 9% net yield = £222k
This assumes no income growth, either, which only increases the capital growth on the investment, example below:
£22k net income (10% rental growth) at a 9% net yield = £244k
As you can see, there are real gains to be made by purchasing the right buy to let property, so get in touch for our seasoned, professional advice at Fresh Invest.Back to news