Martin Hawes: Crystal ball is clouding market

Photo / Chris Skelton

For the past few years, something has been bugging me about residential property investment.

I have long been a fan, but recently something has not been right with the way people have talked and written about it - or the way many have gone about buying rental property.

In the past couple of weeks I have given two presentations on property investment and have also started a new book on the subject. In preparation for these, I looked at rental property with fresh eyes and read most of the current books on the subject.

I found a huge amount of information on the property cycle (especially on "drivers" and "influencers"), on how to structure ownership of property, mortgaging and tenant management but very little on the most important factor for investors - income yield.

There has been a gradual shift in the past decade from investors searching for yield to people trying to play the cycle - in other words, from investment in property to speculation.

The difference between an investor and a speculator is simple: an investor investigates and analyses future income - capital gain is a welcome byproduct, but the investment stacks up on income alone.

A speculator investigates and analyses future price movements - the income is less important as the deal rests on the price movement of what has been bought.

Over the past decade, residential property has not stacked up as an investment at all - house prices are now so high that the rent gives a yield that is too low to interest any genuine investor.

Yet thousands of people are buying rental property. Almost without realising we have turned into a nation of speculators.

The decision whether to buy property for investment purposes is made on the basis of the alignment of certain drivers (immigration, interest rates, affordability, etc) rather than on whether there is good income.

As an investment model, that is unsustainable.

The disregard for income yield has gone so far that I was not surprised by something I overheard at one of the conferences.

Two new property investors were talking to an old hand. The new investors had just made a couple of property purchases. "Great," said the old hand, enthusiastically, "what's the yield?"

The new investors looked perplexed: "What's 'yield?"' they asked.

True investors would be pleased enough when house prices are picked to rise by 24 per cent in the next three years, as tipped recently by an economic consultancy.

However, they would be ecstatic if rents were predicted to rise by that much. An increase in rentals like that not only means more money in the pocket, but keeps the fundamentals of housing in line - ie, there is a reasonable amount of rental for the house's value.

That's the difference between investors and speculators: investors' first concern is the income from what they buy; speculators only care about price movements.

During the boom, house prices rose 100 per cent but rents only rose 14 per cent, which means there is a fundamental breakdown of this relationship, a disconnect ignored by most property writers in their rush to encourage readers into a speculative market.

Ultimately an investment asset will always be valued by its income. If you want to speculate, that's fine - as long as you know that's what you are doing.

However, if you want to be an investor, you have to look for a decent yield.

My benchmark as an investor is that the property would have to yield at least 7 per cent net to be attractive.

I am often asked what you should do if you can't get a yield like that.

My answer is that you should keep out of the market until income comes back into line with values.

It may take years before there is a proper relationship between rents and house values again.

If that is so you should be aware that there lots of other investments (including commercial property) out there - there always are.

When I reviewed what was being written about property in preparation for my conference presentations and my new book, I was impressed by how much the writers and speakers knew about property.

But it quickly became obvious many were ignorant about investment.

I doubt that most of them had ever read Ben Graham or Warren Buffett, knew about discounted cashflows or earnings yields, and if they tripped over the efficient frontier they would expect to get their passports out.

The reasons for this could be that they have a vested interest that has them encouraging people into the market, or they have simply never studied investment.

Either way, a group of advisers and writers telling people what to do with their investment funds when they know nothing about investment is a recipe for disaster.

* Martin Hawes is a financial adviser. His disclosure statement can be found at www.martinhawes.com