What is rental yield?
When deciding whether to invest in residential or commercial real estate, rental yield can be one of most effective ways to determine a particular property’s potential. But what does rental yield mean and how does it affect your decision making process?
What is rental yield?
Rental yield is a measure of how much income your property generates as a percentage of the property’s whole value. In other words, it’s how much you’re making off your property when compared to how much it’s worth. It’s an important metric in property data and one that any investor worth their salt should investigate, understand and calculate.
There are two types of yield: gross and net. Gross yield is often the most quoted and is calculated using two main figures: the annual rental income and property value. It can prove valuable as an overarching guide, but should not be considered when it comes to crunch time.
This is where net yield comes in. This calculation includes all the expenses involved in renting a property and therefore presents a much clearer picture as to the actual rental return.
How to calculate rental yield
As mentioned, there are two ways to calculate rental yield. To calculate the gross figure, you need the annual rental income (weekly rent x 52) and the property value. The second figure can either be what you bought it for (purchase value) or what it’s currently valued at (market value).
Once you have established these, the equation is as follows:
Gross rental yield = (annual rental income / property value) x 100
For example, if you are charging $400 a week, and paid $450,000 for your home, the calculation would be $400 x 52 weeks, divided by $450,000, multiplied by 100. In numerical terms, this is:
Gross rental yield = (400 x 52 / 450,000) x 100
This would result in a yield of 4.62% on purchase value. However, if the value of your home has gone up since purchasing, you may want to consider calculating using the current market value to provide an indication of what you should be charging.
For example, if the same home is now worth $600,000 but rent is still $400 a week, the potential rental yield would drop to 3.46%. With property prices rising but rental prices stalling, understanding the implications can go a long way in ensuring your investment works for you.
Net yield provides a much more comprehensive picture of the income return on any investment, but takes longer to calculate as it requires multiple factors, some of which may need to be estimated.
When calculating net yield, you will need to research all of the expenses associated with a property, annual and one off, including but not limited to:
- Managing agent fees
- Vacancy costs
- Repairs and maintenance
- Council rates and charges
- Transaction costs such as stamp duty, legal fees, building inspections
- Renovations or furnishings pre tenant
- Mortgage interest repayments
You will need to add up all one-off property costs to get a total property cost figure, and then add all the recurring expenses for a total annual expenses number.
The equation is then as follows:
Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100
This translates to the annual rental income minus annual expenses, divided by total property cost and then multiplied by 100.
Therefore, if calculating the net yield on the previous example, the annual rental income is 400 x 52 and the purchase cost was $450,000. The overall cost of purchase was $490,000 and the annual expenses are $5000. Therefore, the net rental yield would be calculated with:
Net rental yield = [(400 x 52 – 5000) / 490,000] x 100
The net rental yield would be 3.22%. For a comprehensive analysis, it’s essential you can estimate or investigate as many costs as possible, in order to present an accurate end figure.
Comparing rental yield
Knowing how to work out rental yield is no good unless you have a benchmark to compare it to. So what is good rental yield? In broad terms, the higher the rental yield, the better the rental return. However, this is a not a one size fits all solution as the definition of good rental yield can change based on individual circumstances, including location, aspect and potential for capital gains.
That said, some cities generally have better rental yield than others, and often, commercial rental yield can offer different results to residential real estate.
According to the latest data from CoreLogic ‘s Top Rental Performers report, the best suburb to invest in is Crigwell, Tasmania, where rental yield for houses is 7.4%. Next is Tweed Heads West in NSW, with a figure of 6.9%, followed by Warrane (TAS), South Lismore (NSW), and Brighton (TAS).
REA Group’s March Property Demand Index correlates Tasmania’s suitability for investment, finding that rental demand is higher in the Apple Isle than almost anywhere else, sitting at more than 40%. It was only beaten by the ACT, where demand sits at 52.5%.
However, it’s not just residential real estate that should be considered when investigating rental yield. Investing in commercial property has plenty of benefits, including strong returns, income stability, low risk, tax benefits and investment control. Most importantly, commercial properties generally have a higher rental yield, sitting between 5-10% net, instead of the residential figures of 3-4% gross. This is due to a few factors – rent reviews are usually included in rental contracts, allowing for increases; tenants pay for rates, taxes and insurances (dropping the annual expenses) and there’s less management needed.
So how should rental yield impact the decision-making process when investing in new property? While important and definitely should be considered, it should not be the only factor you base any decision on.
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