How to Work out Investment Property Yield
If you’re new to the property investment game then you’ll probably come across a lot of terms and language specific to property investment. If you want to invest in property, and indeed, invest successfully, then it pays to have an understanding of just what these terms mean.
One of these terms is ‘rental yield’ and it is probably one of the most important when considering a property investment. If you have any interest at all in property investment, or you have been looking at potential investment properties, then you will have noticed that the rental yield is given as a percentage. So what exactly does rental yield mean, and if it is given as a percentage how is rental yield calculated?
We take a closer look at rental yield, how you can work it out, and just why rental yield is so important for investors.
What is rental yield?
The yield on an investment is usually a part of high school maths curriculums, but in case you need a refresh, a yield refers to the measurement of earnings generated by an investment. Rental yield refers specifically to the income generated by a property investment through rent. We already know that it is expressed as a percentage, but it is also calculated according to a set period and rental yield is calculated annually.
How to calculate rental yield?
To calculate the rental yield on an investment property, simply work out the annual rental income and divide it by the purchase value of the property. You will then need to multiply that figure by 100 to give the correct percentage. The following formula can be used to calculate the rental yield on an investment property:
Annual rental income (weekly rental income x 52) / property value x 100 = rental yield
For example, a property investment with a weekly rental income of $500 has an annual rental income of $26,000. If the property was purchased at $600,000 the rental yield will be 4.3%.
However, the world of property investment isn’t that simple. A property investment comes with potential costs that will impact upon your return. For this reason, rental yield can be divided into two groups: gross yield and net yield.
What is gross yield vs net rental yield?
The gross yield on a property investment refers to the rental yield before expenses. Expenses may be annual or part of the total property cost and include:
- Purchase cost
- Transaction costs such as stamp duty, legal fees, building inspections etc.
- Loan fees
- Agent fees
- Maintenance and repairs
- Strata levies
The formula above does not account for expenses and therefore it can be used to calculate the gross rental yield.
The net yield is the rental yield after all expenses are accounted for. The following formula can be used to calculate the net yield:
Annual rental income (weekly rental income x 52) – expenses / property value x 100 = net rental yield
Expenses surrounding property maintenance, mortgage repayments and strata levies can be significant and this means they have a big impact upon the investment return. Although you can never be sure of all expenses before investing in a property, you can make an educated estimate to give you an idea.
When considering whether a property is a wise investment it is best to look at the net rental yield rather than the gross rental yield. However, the gross rental yield may be more helpful when comparing different properties. It is also especially important to watch out for real estate agents quoting the gross yield rather than the net yield.
What does rental yield percentage mean?
Once you have your rental yield percentage figure you can work out the earnings on your investment. Using the figures from the previous example, a property investment with a purchase value of $600,000 and rental yield of 4.8% will have a gross annual income of $28,800.
The rental yield percentage is an indication of just how a property investment may perform. As previously mentioned, it is also helpful when comparing properties with different purchase prices and rental returns. Investors should be aware of ‘average rental yield’ as this figure may not be an accurate indication of how a particular property in an area will perform.
Often new investors will be told to look for a property with the highest rental yield, but it is important to make sure it is the net yield you are looking at. Even if a property offers a high net yield, there are other factors, such as capital growth, that an investor will need to review when considering if a property is a wise investment.
What about capital growth?
Rental yield is separate to capital growth. While rental yield calculates the rental income, capital growth refers to the increase in value of the property. For most investors, a property with good capital growth is essential for the health of their entire property portfolio.
Even with a good rental yield, a property with little or no capital growth may not be a healthy investment. It is therefore important that capital growth and rental yield are considered together when deciding upon an investment property.
Why is rental yield important for home buyers?
Rental yield is important to both investors and home buyers as it is an indication of the return that a property is likely to give. There are many costs to weigh up and balance when investing in property including loan repayments and ongoing expenses such as maintenance and insurance, so it it helpful to have a figure that expresses the potential rental return. The rental yield will enable you to work out your potential cash flow and profits.
What is a good rental yield?
It’s a great question, but the answer is not so simple. It would be nice if we could put a figure to the ideal rental yield, but there are unique circumstances surrounding every property and each investor.
Ideally, an investor wants their property investment to pay for itself. That means, rent money is covering the mortgage repayments and there is enough cash flow to cover maintenance and unforeseen repairs. A good rental yield is a yield that covers all these things so the property is self-sustaining and ultimately provides a return.
Take, for example, a unit in an older building offering an 8% rental yield. It may sound like a good investment, but the older building is in need of repairs and the strata committee have introduced special levies for the repair work. A unit in a newer building offering a 5% rental yield, without the special levies, may be a better option. Even with a 3% difference, it may not be enough to cover the special levies and the investor may incur losses rather than profit.
Ready to invest?
You’re ready to browse the property listings! With an understanding of rental yield, you’ll be able to compare potential investment properties and determine if they might be a wise investment for you. Rental yield is just one of many factors to consider when taking the plunge into the world of property investment.
At Mortgage House, we are no stranger to the homeowner’s journey. It’s a long (but rewarding) one.
For more information and advice, contact us and speak to a Mortgage House Lending Officer about your property investment plans.