The gentrification of Sydney's inner west has seen its property market scale new heights in recent years, with record sales and very strong levels of capital growth. But as the city’s property boom now eases, as many experts suggest, just how should an investor view the inner west?

The answer depends on whether you're focused on capital growth, rental yield, or perhaps both. For a start, several inner west suburbs are still drawing high prices and any drop off was never going to be sudden. For example, houses in Marrickville and Dulwich Hill soared in value by 30 percent in the year to December alone, as per CoreLogic RP Data, while houses in nearby Haberfield, Leichhardt and Concord also climbed by more than 20 percent in that period. These kinds of increases have delivered high capital growth, while rental yields have mostly remained flat.

Keep in mind that gross rental yield is a measure of how much rental income your investment property brings in each year as a percentage of the property’s price or market value. And so the high value of inner west property generally, is an important factor when calculating potential future income. Recent million dollar sales in Marrickville, Leichhardt, Concord and Lilyfield, as per auction results from the Domain Group in mid February, show that there's continued demand from buyers in the inner west, but perhaps not always from renters. For example, in Concord the average gross rental yield is about 2 percent on houses and 3 percent on units, according to the REA Group.

This lines up with CoreLogic RP Data's broader analysis that Australia's capital cities have really seen little change to gross rental yields across the capital cities over the last 10 years. Average capital city rental yields are now at an historic low of 3.5 percent, the data service company says, which is well below the 5 percent figure that some property experts say is the benchmark for a sound investment, given that it converts to $1 in weekly rent for every $1,000 spent buying a property.

As an example, a property that’s purchased for $700,000 and returns a weekly rent of $700 would have a gross rental yield of 5 percent (700x52 / 700,000 x 100).

However, given the inner west's proximity to the CBD, and the range of amenities it offers, including trendy cafes and bustling weekend markets, it clearly remains very appealing to renters. As such, principal of Ee Real Estate, Poh Ling Ee says that investors are still looking favourably at rental investments in the area. 

"There's good rental income in the inner west because you're close to the city, you've got train stations and the lifestyle is good with its restaurants and cafes," she says. "The train station is very important for rentals. You've also got Sydney Uni the Prince Alfred Hospital [nearby]." 

Poh agrees with the idea that some inner west suburbs have seen such strong price increases, however, that many ongoing investments tend to focus on capital growth alone.

"For example, you're still paying quite high prices in Newtown, Erskineville and Alexandria, but the rental income isn't as good in Alexandria as it is in Newtown," she says. 

Newtown’s better rental yields, especially on units – 4 percent, says the REA Group - might be attributed to its iconic main drag along King Street, which essentially keeps tenant demand high amid a limited supply.

"In Alexandria you're starting to get shops and cafes but it's not like Newtown. In Newtown you have shops and cafes, cinema – everything," says Poh.

Director of Ray White real estate in Concord, Joel Hollis echoes this sentiment and says that tenants are like buyers and investors - they're looking for convenient locations.

"If you've got a new apartment that you've bought, for example, and it's close to schools, shops, train station, cafes and restaurants - they're all big pluses for people [renting]," he says.

From the investor’s perspective, Hollis notes the importance of stacking up the purchase price with rental income expectations. In Haberfield, for example, there are many attractive older family houses and not as many units, which both pushes up the suburb's median price point and limits the range of property options for tenants. This is probably why rental yields are rather low in the suburb – 2 percent for houses and 3 percent for units, says the REA Group.

"If you're buying a home there for $2m, and you're only getting $900 a week then it [a rental strategy] doesn't really make sense," says Hollis.

"All the properties selling there are mostly going to families that are owner occupiers, whereas in Leichhardt there are quiet a few new developments going up, which is also close to the CBD, and there's also going to be high demand due to location." 

Investors can't always rely on location, though. Too many new developments, for example, can also create an oversupply in the rental market and impact rental returns. This is important in the context of the inner city and inner west because there's plenty of development in this segment of Sydney.

Poh says that renters will often choose a newly built apartment with a modern design over an older property, if the price suits their budget. This certainly needs to be factored in when purchasing a property with a view to long-term rental returns.

Overall, the inner west continues to draw crowds because it offers desirable property in vibrant neighbourhoods, but also because it's so centrally located. These factors should help rental incomes hold steady, though the cost of buying property in a still buoyant Sydney market, will likely impact rental yield growth in many inner west suburbs in the near future.

By Jean-Paul Pelosi

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