Timing the Sale of Your Investment and Yield
It is perhaps human nature for investors to focus on the purchase phase in property investment, paying less heed to the selling phase until it becomes necessary for financial or lack of time to manage the property. Additionally, we are all bombarded by marketing messages to tell us what the next best place is to buy, and how we should part we our cash. In this short article we will look at methods to plan the timing of the sale of your investment in a methodical way, making this part of your business as pro-active as the purchasing side. Even with yield investments, the capital appreciation for property held more than a few years usually far outweighs the rental income, so it makes good sense to plan the release of your hard-earned money well.
Yield Depression / Compression
I will use a term used by investors commonly during this article, yield compression or sometimes known as yield depression. Sounds like a bad thing, right? Well quite the opposite if it is a market you are invested within. Lets say you purchase a property at a point when the yield is 10%, based on a sales price of 100,000 Eur and 10,000 Eur rental income a month for simplicity. You hold the property for 5 years, and you then measure the yield based on the value of the property at that stage. Unless the investment climate has remained entirely static, unlikely, one of 4 things will have happened, or a mixture of 2 of the 4:
1. The property value has increased.
2. The property value has decreased.
3. The rental income will have increased.
4. The rental income will have decreased.
If effect 2 or 3 have occurred then the yield will have expanded during your hold period.
Say the property value decreases to 80.000 Eur and the rental income increases to 12.000 Eur per year then the yield will have expanded to 15%.
In every market that ProVenture have participated in during the last 20 years, we have noticed the opposite effect, yield compression, if the investment is held for longer than say 3-5 years, but often much shorter. So, using the example above, the property value may increase to 140.000 Eur and rent increases to 12.000 Eur per year over a given period.
This would give a yield of 8.6%, so the yield has compressed from an intial 10% to 8.6%.
We will next analyse each of the markets we have participated in during the last 20 years to see how anlaysing yield compression can assist with planning the sale of your investment.
We will restrict the scope of this article to property sold to an Investor [you!] and sold on to another investor, so multi family houses or apartments in areas where investment-held property is most common.
The market for sales from an Investor to private owner occupier market is down to access to finance and ability to pay that finance, and a number of other factors associated with the economy and supply of property. This method of sale is really another story, covered in our guide to splitting apartments – there are huge potential rewards here but they are not based purely on yield on disposal.
Examples of Markets – ProVenture Operations
London and SE UK
We participated in this market purely as investors during the period 1994 – 2001. Of the property held in the investor to investor market, typical yields on acquisition around 1994- 1996 were 10-11% with acquisitions made at around £55,000 with a rental income of £6,000 per year being typical. With mortgage rates at around 7-10% at the time, not much money was being made. By 1999, the property held had increased to around £125,000 and rental income to £9,000 per year, or a yield of 7.2%. Properties were disposed of between 1999-2001, whilst the yield through capital appreciation fell below 6%.
Aberdeen – Scotland
ProVenture participated as active investors in this market between 2003-2005 [although some property still held to this day]. Typical investments were 1 bedroom apartments within tenement buildings, such as the above right picture, and were sold to a market of investors in the main. On acquisition, typical prices paid were £30,000 with around £3,600 per year rental income or 12% yield. By 2007, after only a 2-4 year hold, prices paid rose to around £80,000 and a typical rental income of £4,800 per year or 6%. This rapid yield compression was a very clear signal to do something [in retrospect]. From 2007 to today, the period of the financial crises and its aftermath, typical prices for these properties would be £60,000 and a rental income of £5400, or a yield expansion to 9%. We will pick up on this story later.
When yield investments were no longer possible in the markets of UK, ProVenture began acting as both investors and consultants in 2006 in Berlin. Price increases in the better areas of the city from around 2002 meant that investment areas in the B or C grade areas of the city were most active, and still are to an extent today. The picture shows a typical apartment house in the C grade district of Neukoelln. In 2006, this property sold for 500.000, with 55.000 Eur net income and with a yield of 11%. Today’s figures would give a sales price of around 850.000 Eur and a rental income increased to 66.000 Eur, or a compression to 7.8% yield.
As investors and consultants, this market has been the prime area of activity from 2007 to the present day. In 2007-08, apartment houses in the A- grade parts of the city were most active, say in the district of Schleussig where the properties pictured above are located. The house on the right sold for 450.000 Eur with a rental income of 51.000 Eur per year or a yield of 11.3%. Today the rental income is 56,000 Eur per year and a likely sales price of 800.000 Eur would be expected, giving a yield compression down to 7%. Other parts of the city have favoured differently, with the south and west generally compressing more and having greater ability for rental increasements.
USA – Downtown Orlando Market
The market in downtown Orlando is one that ProVenture have operated to a limited extent for the last 12 months, principally research although some investment has been made by our team and our clients. The above is a single apartment sold in Dec 2010 for $38,000 with a net rent of $5,400 per year and a yield of 14.2%. The above apartment is now on the market for $55,000, with the same rent level, showing a compressed yield of 9.8%.
This is a new market for ProVenture in 2011. This property is a well-located apartment house sold in September 2011 for 255,000 with an annual rental income of 29.000 Eur and yield on purchase of 11.3%. The typical yields in this market are 9-13% today.
Another new market for Proventure in 2011. Above are listed 2 property offers near the city centre. The offer on the left is listed at 293.000 Eur, with a current yield of 11% and on the right is an offer for 700.000 Eur with 13.5% yield today.
We have examined the yield compression using the markets that ProVenture has participated in during the last 20 years, showing markets we have exited through to markets that are new to us during 2011. Interestingly, each market we have participated in for any length of time show yield compression through capital increases, often whilst rental levels are also rising. This is of course re-assuring for us, we work hard to select markets which we feel will perform well both on an income and capital basis. But the more important point is to examine what the amount of yield compression tells us about the timing of any disposal. It seems, for property sold onto investors, that a yield of around 1-2% above the rate of investor finance seems to indicate a point where capital values findsome level of equilibrium. One of the longest markets we have participated within, Aberdeen in Scotland, showed yields compressing from 2003 levels of 12% down to around 6% in 2007. Of course we entered the financial crisis after this point, which perhaps accelerated capital falls, but yields now have expanded to a point of 9% through price falls of around 25%.
What should we make of all of this? Well, we can first see that even when buying income producing property, capital increases can often [indeed always in the markets we have participated within] outweigh the money from rental income. A search of the markets we have operated in show that capital increases have outweighed income by around 700%, a surprising amount when we crunched the numbers. So, we should try and plan and manage this effect as much as we plan and manage the rental income through the hold period.
The Bid Idea –
It seems prudent to put a marker down for exit yield, as well as the yield off which we analyse new purchases. By analysing the markets we have operated in over the last 20 years, an exit yield of around 2% above finance pay rate has been seen to be a useful measure for when prices usually level off. That’s not to say someone rings a bell when the peak in the market has been reached, markets can often overshoot this yield level particularly where a high proportion of owner-occupiers are in place, where yield is not a consideration and only ability to service finance is considered.
Having learned some of these lessons the hard way over the last 20 years, I now put on my spreadsheets an exit yield for each property, and put to the market once the property nears this. But the real fun is looking for new markets in which to operate, ones that show signs for future yield compression or rental increases. That’s our job at ProVenture. Do get in touch if you want to discuss topics in this article, or markets that we are operating in or markets that you are considering for investment.