If the rental yield is too good to be true, it is likely, not true.
You are looking at a property and at first glance, it has an excellent rental yield. In fact, the rental yield is much higher than you have expected. It is fetching more rentals than other properties in the area. It is too good to be true.
I have come across one such property a few years back. The property was operating as a spa. The asking price of the place was $5 million and was fetching $15,000 per month. The rental translated to $12 psf, which is much higher than any other property in the area at that time.
I went back to the golden rule to assess the property investment:
For every $1000 purchase price, one should be confident to fetch $2 psf of rental.
The property I was considering was a simple retail shop without any F&B usage. Such properties in the area usually cost $3,000 psf. You could buy it at a lower price. Then, if it is rented out to a tenant who is not an F&B, it could fetch around $6-$7 psf per month. That is the standard market rental rate.
Even if the property had an F&B allowance, the best it was expected to fetch was a $10 psf rental per month. Therefore, the $12 psf for non-F&B usage retail shop sounded too good to be true.
Also read The secret to maximising your shophouse rental yield.
Future roadblocks to buying a property with rental above market rate.
- You will have to pay a premium price to buy due to the current high rental yield fetched by the property.
- The current tenant may wish not to renew their tenancy agreement when they realise they can easily rent other places in the area at a lesser rental.
- Hence, even if the property is fetching good rental now, it would be short-lived.
- To top it off, the new tenant may not agree to pay the high rent at which the former tenant was renting the property because it is above market price.
- Therefore, the premium price you paid for the high rental would be pointless. You will have to accommodate to lesser rental income even though you paid a premium to buy the property.
- You will ultimately have an expensive property with lower rental translating to an income loss, or lower return than your expectation.
Fortunately, I could bargain the property I was dealing with to sell at $4 million even though the original price at which the seller bought the property was $5 million. The owner agreed to sell at $1 million less on the condition that the property was to be sold as vacant possession. We agreed because the negotiated price of $4 million meant we were not paying a premium for the price. Thus, renting the place at the current market rate was justifiable and worth our investment.
Once we bought the property, we managed to rent it out to an Ultra-luxury watch shop. It’s now in extensive renovation anchored with a high luxury watch brand. They are paying at the market rental yield which is growing over time to provide an appreciable rental yield for the property.
Key things to avoid a too good to be a true rental yield!
When rental is too good, evaluate the fundamentals. Based on the case study, we can assume how to not so be explicit that the seller is cheating.
Do not purchase the property based on tenant profile or high rental. as then you will end up paying a lot of premium for the rental yield.
Always come back to the golden rule of property investment when assessing the right rental of a property.
As an owner, you own the property for the rest of your life or for the remaining lease of the asset but tenants can change anytime. They can be out of business or move out. Then finding a new tenant at the previous tenant’s rental can be a challenge.
The key thing is not to purchase property with an over premium that you are forced to rent high.
Want to find a property with a high but healthy rental yield?