Rental yields explained
What exactly is rental yield and how can you factor it into your investment strategy?
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Rental yield is a way of determining the profitability of an investment property in relation to its value. The higher the rental yield the more profitable your investment is. Of course, not every investor is solely concerned with rental income. Growth in the value of the property itself over time (your capital gain) is very important too.
Understanding rental yield can help you when looking at multiple properties in a portfolio, or when considering future purchases.
What is rental yield?
Rental yield is the amount of money made on an investment property. The amount left over after deducting costs from the rental income on your property is the rental yield.
By understanding the rental yield on a particular investment property, you can calculate how long it will take to reach your investment goals. It will also tell you whether you're better off searching for a property in a different suburb where the rental yield may be higher. A higher rental yield generally means a greater cash flow.
Rental yields are sometimes referred to as "hard" or "soft". A hard rental yield is one that is falling, usually as a result of property prices increasing, while a soft rental yield is one that is increasing.
How to calculate your rental yield
There are a few ways to calculate rental yield.
Gross rental yield
Gross rental yield is calculated by taking the total annual rent charged and dividing it by the property value. Multiply this number by 100 to give you the gross rental yield as a percentage.
The formula is: (annual rent divided by purchase price times 100 = gross yield)
Here's a simple example:
- Investment property purchase price: $700,000
- Weekly rent charged: $450
- Annual rent: $23,400
- 23,400 divided by 700,000 times 100 = 3.34
- Gross yield = 3.34%
Net rental yield
Net rental yield includes the above calculation and all costs incurred. This could include insurance, rates, property management and repairs. To calculate the net rental yield, you take the total annual rent charged minus all incurred expenses. This new number is divided by the property value and multiplied by 100 to give you the net rental yield as a percentage.
Return or a total rental yield
Return or a total rental yield refers to the total gain or loss made on an investment property over a specific period. Unlike gross or net rental yield, a return includes capital gains and can be either a dollar number or a percentage. The return is wholly focused on past performance and does not take into account potential future earnings.
Although gross rental yield gives you an overall figure, it's the net rental yield that helps you see your true profit for the year. Ongoing costs or costs that fluctuate greatly can also lead to your rental yield changing year on year.
How do I research investment rental returns?
Start by looking at the average rents in a particular suburb you are interested in as well as the surrounding suburbs. Look at the rental yields for comparable properties in comparable suburbs or ask estate agents.
Be sure to ask whether a yield advertised is gross or net as well as the period of time the yield has been calculated on. A gross yield will appear much higher, but be wary of the net yield if there are significant costs involved with the property.
What is considered to be a high rental yield?
Rental yields vary considerably and it's difficult to say what you would consider to be a high rental yield. Generally speaking, most investors look for a rental yield of 5.5% or above.
The best advice would be to research the market and suburbs to determine an average or above average rental yield. A high average rental yield could mean your property is undervalued within the market.
What other factors should you consider besides rental yields?
Ultimately, there are a number of factors to consider besides rental yield to determine whether a particular investment property is a money maker. Start by considering the total return on a property against the potential risks.
Look at drivers of capital growth for a potential property such as the location, population and economy of the local area. An area that is growing or has new infrastructure planned is much less likely to have rental vacancies, which can severely impact your investment profits.
Rental yields are merely one part of a bigger picture. Zoom out and focus on the overall factors before making an investment decision, and enlist the advice of a professional who can advise you on the current market conditions.
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