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Benchmarking rental yields-residential property developers

Rental yields are a function of gross rent charged and property prices, while the former is directly dependent on the income level of a country or a region, the latter is influenced by a variety of factors including public policy, demand-supply gap and speculative appreciation. Thus, this results in varied rental yields. Although high rental yields augur well for the real estate sector and economy, low yields indicate low affordability for consumers owing to income and price gap.

The above chart depicts that there is no direct co-relation of a country’s income levels (GDP per capita) with rental yields. The USA had a double rental yield as compared to Canada, despite having similar income levels and Hong Kong had a lower rental yield than India despite a higher income. Therefore, it becomes all the more significant to understand this variability through price to income and price to rent ratio.

In order to determine whether a house is fairly valued, one need to look at the relationship between the price to income and rent. If rising prices move this ratio above their long-run historical average, then either income or rents are likely to rise or house prices will fall. The house prices increased significantly in Canada, Germany, United Kingdom and Asian countries such as Hong Kong and India and pushed the ratio well above their historical averages. Moreover, since income levels are not expected to grow in line with the current economic scenario, the prices are set to fall.

     

However, globalisation has created a handful of mega cities that attract talent and capital from all across the world. Thus, house prices in such places outpace the national average irrespective of their national economic performance. In the major European cities, the house rates are growing twice their national average. Further, house prices in London, San Francisco, and Vancouver have risen by 13% on an average, over the past three years, while the national prices have risen by 7.5%, pushing the affordability in these cities to out of limits.

Therefore, due to the highly localised nature of the housing industry rental yields may continue to vary between cities in a country and even within localities in the same city. Hence, when comparing the performance of different residential property developers, it is important to focus on the type of housing (affordable or luxury), location, income levels in a locality, etc. The cost may also vary depending upon the regulatory body, time taken for approvals, labour and material prices, etc. A comparative analysis of REIT’s performance in the United States (the country with highest rental yields, thus making the REIT’s more feasible) is given below. 

     

As per the above chart, while Essex Property Trust (managing premium homes in California) had a higher rent per apartment than Mid-America apartments (managing mid-size homes in less populated cities) and its net rental yield was lower. Therefore, a higher rent may not always translate into higher yield for a player as property maintenance costs, taxes, and employee expenses also increase based on the location. Although property maintenance and operating costs for Mid-America was ~31% of the total cash OPEX it was ~58% for Essex (FY 2015).

A successful player in the residential property development (for rental) should focus on maintaining net rental yields through cost optimisation, at the same time should not lose sight of the long-term macro parameters such as occupancy, which is driven by demand for rental apartments in an area.

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