Make Better Investment Decisions By Understanding Rental Yield
When looking at investing in property it’s important to understand a number of critical factors for your return on investment, including how to calculate rental yield. Understanding what rental yield is and how you can calculate it can significantly impact your decision to invest in a property.
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What is rental yield? And What Does It Have to Do With Annual Rental Income?
Rental yield refers to the yearly profit margin on your investment property. Essentially, your rental yield is the income you receive after costs. Costs can include overheads or unexpected expenses, for example, mortgage repayments, maintenance or repairs, depreciation, fees, and taxes. What costs you include will depend on whether you are calculating gross rental yield or net rental yield.
These are important figures to know before purchasing an investment property, as they will be one of the most significant factors influencing the financial success of your property.
It’s also important to continue to calculate rental yield ongoing, after purchasing a property, to understand how it is performing as an asset and whether you need to consider taking action to get or increase a return.
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How to Calculate Rental Yield
How you calculate rental yield depends on whether you’re calculating gross rental yield or net rental yield. Gross yield is more commonly used, especially when you are assessing whether or not to buy a property (as you may not know all the costs involved in a property before purchasing), but a net yield is more accurate for determining a property’s potential performance.
Gross Rental Yield
To calculate gross rental yield you simply divide your annual rental income by your property value (purchase price or market value), then turn that into a percentage to reveal gross rental yield. This can be expressed as the following formula: Gross rental yield = annual rental income/property value x 100.
To break that down, here are the steps:
Step 1 – Add up your rental income for the year to get your total annual rent, i.e weekly rental income x 52
Step 2 – Divide your annual rent by the value of your property.
Step 3 – Multiply that figure by 100 to show your gross yield as a percentage.
As an example, the median rental price in Newcastle, NSW, in 2022 is $695 per week, which equals $17,940.00 annually.
If the market value of the property is $600,000, that means we divide 17940 by 600,000 (0.0299) and then multiply that by 100 (2.99%). I.e. (695 x 52)/800,000 x 100 = 2.99% gross rental yield.
Net Rental Yield
Net yield tends to be more accurate as an indication of a property’s potential, as it uses as much information as you can get – the more information you have, the more accurate the result. To calculate net rental yield you will need to take into account costs that have to be paid, regardless of whether or not the property is occupied. These property costs include:
- mortgage repayments
- taxes or legal fees
- initial investment, i.e. deposit, stamp duty, etc.
- property management fees
- insurance costs
- annual maintenance costs (for example, fire alarm checks)
- additional expenses or unexpected costs
Essentially, you find the net annual rental income (income minus expenses) and proceed with the formula as before. This can be expressed as the following formula: Net rental yield = (annual rental income – annual costs and expenses)/property value x 100.
To break that down, here are the steps:
Step 1 – Add up your rent for the year to get your annual rental income.
Step 2 – Add all of the expenses you incurred during the year from owning the property refer to list above for ideas).
Step 3 – Subtract the annual expenses from the annual rent to get your net rental income.
Step 4 – Divide the net income by the value of your property.
Step 5 – Multiply that figure by 100 to show your net yield as a percentage.
Using the same examples as before, the average median rent in Newcastle, NSW, is $695 which equals $17940.00 – this is the gross income. Over the course of the year, you’ve paid out approximately $10,000 in costs – you would minus 10,000 from 17,940 for a net income of $7,940. Divide this net income by the property value of $600,000 (0.0132) and then multiply this number by 100 (1.32%) to find your net rental yield percentage. I.e. ((695 x 52) – 10,000)/600,000 x 100 = 1.32% net rental yield.
As you can see, gross vs net can produce very different results, but you do need to have a lot of information to use the net formula. In circumstances where the total property costs may not be available to your yet, the gross formula is still useful for indicating a property’s potential.
What is a Good Rental Yield Percentage?
There are many factors that influence a property’s value, performance, and potential, so it can be difficult to say what is a “good” percentage in terms of rental yield. Differences in returns can depend on things like where your investment property is located, what type of property it is, how much it’s worth, and so on.
Generally speaking, a positive return for a metropolitan area (capital cities), yields around 3% or more is considered a good return. In rural or regional areas, 5% or more could be considered a good return.
What other considerations should I be aware of?
When making an assessment of a property based on rental yield, it’s important to be aware of a few factors.
Past Performance of a Property
Past performance can be an indicator of where a property is likely to appreciate or depreciate, and the potential of returns. While unexpected market events can throw you some big curveballs, past performance can be one way of setting your expectations for a property’s potential for financial success.
Local Property Market
Characteristics of the local property market can make a significant impact on a property’s value and future potential. Influential factors to consider include the location of your property, current rental demand in that area, planned development for the area, vacancy rates, and house prices. There is a lot to consider when looking at investing in a property and you need to approach understanding a property’s value and potential from past performance, present conditions, and future potential.
Key Takeaways
- Rental yield is the annual profit margin from an investment property, distinguishing between gross and net yields.
- Gross rental yield is calculated by dividing annual rental income by property value, then multiplying by 100 to get a percentage.
- Net rental yield accounts for annual costs, offering a more precise performance measure.
- Ideal rental yields vary, with 3% considered good in metropolitan areas and 5% in rural areas.
- Understanding rental yield is crucial for making informed property investment decisions.
Interested in the Possibilities of an Investment Property?
If you’re interested in owning an investment property or renting an existing one out, it’s important to seek professional advice first – here are some things to consider before buying your first investment property.
If you are looking for general advice to start your property investment journey, get in touch with Pippa and the Investment Services team today.
