Why Yield Will Not Fall When Rents Are Falling

reduced rent will not lead to a reduced yield
Reduced rent will not lead to a reduced yield

I have my reservation to the Straits Times Article titled – “Home rents falling, but yields not plunging yet“. Just by looking at the title, I have the impression that yield is supposed to fall in when the rents are falling. At first, it feel logical that if we are receiving a lower rent, our yield should reduce accordingly, but on second thoughts it is not entirely true.

How to calculate yield

Yield is basically the percentage of rental income over the property price/value. Any changes in yield is dependent on not only the rental income but also the property value.

Yield = Annual rental income / Property Value X 100%

When will yield plunge?

Let’s assume the reduction of rental income by 15% in three scenarios of property value behaviors (less 15%, stays the same, more 15%)

rent reduction vs yield.JPG
Yield sensitivity in response to rental reduction of 15%

From this simple example, there are two scenarios where the yield is reduced, the most unlikely case is the increased property price when rents are falling. Another situation where yield has dropped is when the property prices stay the same while rents are falling, which is equally unlikely. The most likely outcome (which is happening right now in a down market), is both rents and property prices are falling at approximately the same rate. Hence, we see that the yield is actually not falling as expected.

When rents and property prices fall at the same time, yield will not plunge

Do note that, yield can be highly sensitive for different home owners who have different entry price, loan percentage and tenant supply, so please do a quick estimate for yourself!

 

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18 thoughts on “Why Yield Will Not Fall When Rents Are Falling

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