Before you buy an investment property, you’ll likely calculate its rental yield. The yield on an investment property details the future income you can expect to make represented as a percentage on an annual basis. This not only helps you determine if a property is suitable for your wealth-building goals, but it gives you something to compare against other investments where returns are typically measured as a percentage on an annual basis.
It’s important to understand the different terminology used for the investment terms associated with a property. For example, you may hear a real estate agent speaking a lot about a property’s return. The property’s past performance is important, but it doesn’t help you understand the future earning potential that the property could provide.
Here we take a look at the four main terms used to determine the earning potential of a property:
- Real estate yield: Measures the future income on an investment as an annual percentage. It’s based on the cost or market value of the asset and has nothing to do with capital gains.
- Gross rental yield: The gross income on an investment before expenses are subtracted. Expenses on a rental property can be pretty substantial, so sometimes there’s a large difference between a property’s gross and net rental yield.
- Net rental yield: The income on an investment property after expenses have been subtracted. Typical expenses include purchasing and transaction costs, building and pest inspections, advertising, repairs and maintenance, management fees, insurance and rent lost through vacancy. Most often you will need to estimate these as it can be impossible to know prior.
- Return: The total gain or loss on an investment over the holding period. This includes capital gains, and it’s usually expressed in dollars or as a percentage based on the amount of profit made on the investment.
How do you calculate rental yield?
There are 3 steps in calculating a properties rental yield. Get out your calculator and lets get started:
- Calculate the annual rental income of your property eg: weekly rent x 52
- Subtract ongoing expenses and vacancy costs from the annual rental income
- Divide the number you calculated in step 2 by the value of the property
- Multiply the number you calculated in step 3 by 100.
Eg: You purchase a property for 500K which you rent out for $475 per week and our annual expenses are $4000 (advertising, repairs/maintenance, insurance etc) the formula in calculating your net rental yield would be:
Annual rent of $24 700 ($475 x 52) – annual expenses of $4000 = $20700 $20 7000 / property value of $500 000 x 100 = 4.14%
What rental yield range am I looking for?
It really depends on what is suitable for your financial situation and your wealth-building goals. If you’re more focused on cash flow, you’ll probably choose a higher-yielding property with fewer prospects for rapid capital growth. On the other hand, you might buy a property with significant capital growth potential but a lower rental yield. Each scenario will have its own set of considerations to review.
When you are shopping around for an investment property, you will hear comments about yields. Often the yield being referred to is the gross rental yield and not the net rental yield which will provide a higher percentage so make sure you ask which yield they are talking about.
Even if you’re not currently looking at buying an investment property, calculating the gross and net rental yield on your current properties to determine what changes you could potentially make to increase your yield is worthwhile doing and we recommend you speak with a qualified and legal professional for tailored advice before you make any big changes to your finance and investments.
We’re not financial advisors at Revolve Property, we’re just excellent property managers. We’ve provided the information in this article to help you understand more about getting the most out of your investment property, but it should not be considered financial or legal advice. We recommend talking with a financial advisor before making any investment decisions. Our mates at Inception Wealth Group would be happy to help you out and you can request a call here.